Divorce is one of those life events no one wants to consider as a possibility, let alone plan for, yet more than forty percent of all first marriages end in divorce. So, the first thing to recognize if you are going through a divorce is you are certainly not alone. The second and most important thing to understand is that divorce is a highly emotional time during which far-reaching and irreversible decisions are made, most of which deal with personal finances. Amid the emotional stress and strife that might take place, it is vital to have a clear and reasoned plan for post-divorce finances.
Common Financial Issues During a Divorce & How To Avoid Them
By following these personal finance tips when going through a divorce, you stand a better chance of having financial stability in your new life.
Seek Legal and Financial Counsel
At the very moment you are even considering a divorce, you should seek the counsel of a divorce lawyer who can walk you through the various financial issues you will face. If you are already in the divorce process, it is never too late to hire counsel. Your objective is to get all of the financial issues both of you are facing on the table. That includes child support, maintenance, and the division of assets. The quicker you can do this, the sooner you will know what you will be facing in terms of agreement and disagreement. Hopefully, this can be done amenably early in the process.
Prepare for a Drop in Income
Many divorces end with one or both spouses experiencing a drop in income, which may force some lifestyle changes. In anticipation of that, create a spending plan based on your post-divorce expenses, focusing first on your essential expenses (i.e., housing, food, utilities, insurance), including an amount to set aside for savings each month. You will want to ensure you have enough money set aside for emergencies. Then add non-essential expenses, prioritizing and cutting back if needed. Using a free personal finance app, such as Mint.com, can make the job of listing, categorizing, and tracking your expenses much more manageable.
When you start contemplating divorce, gather all your financial statements, including bank accounts, brokerage accounts, life insurance cash values, retirement accounts (both individual and company-sponsored plans), real estate deeds, business valuations, and trusts.
List all assets, how they’re owned (individually or joint), and assign a value to each. If one spouse has a pension benefit through work, it will be essential to know the present and future benefits to determine an equitable split. A pension evaluator can help you with that.
You will also need to gather information on wages, investment income, and other income sources. That can best be obtained with past tax returns covering at least three years.
Finally, create a list of all debts, including credit cards, bank loans, car loans, student loans, life insurance, or retirement plan loans, and who originated them. Typically, all debt created during a marriage accrues equally to both spouses, but you should know what you’re dealing with ahead of time.
You will go through a similar exercise during the divorce proceedings, but it’s essential to have this done ahead of time if you have any questions or need clarification.
Establish a Budget
If both spouses intend on maintaining a similar lifestyle after divorce, it will require some strict budgeting now. Legal costs will eat into current cash flow and savings, and as a divorced family, your living costs will increase. Taking steps now to list all essential and non-essential monthly expenses and tracking them will enable you to get control over your finances, making it easier to transition into post-divorce life.
It may require eliminating some discretionary expenses, but you need to keep your eye on the target. It may also require downsizing your life in different ways (smaller home, cheaper car, less expensive location, etc.). The key to staying in control of your finances and building wealth is to live within your means.
Reduce Your Debt
Many couples going through divorce increase their debt primarily due to legal costs and the increased expenses associated with separation. Debt created during divorce accumulates to both spouses. If either spouse needs to go into debt, try to get an agreement to use a separate credit account. Otherwise, as part of your budget, you should do as much as possible to reduce the amount of debt you both will carry into your new lives.
Stay on Top of Your Finances
Most of your bills, including your mortgage, auto loans, utilities, credit cards, taxes, and insurance, are most likely all a joint responsibility. Ultimately, these will have to be canceled, refinanced, and transferred according to the agreement you reach in your divorce accord. For now, it is vital to agree on responsibilities for their payment to guard against hurting your credit.
Factor in Tax Liabilities
In the year your divorce is finalized, your tax status will change from filing jointly to filing as an individual. Be sure to factor in the potential for a higher tax liability, especially if you were the higher-earning spouse.
As part of the inventory exercise, it’s important to determine the after-tax value of each asset. For example, if one of the assets is a 401(k) plan worth $100,000, it will have considerably less value than a $100,000 bank CD. For each asset, you need to know the equivalent after-tax value before you start a split negotiation. A CPA or tax professional can help with that.
Obtain Separate Credit
If all your credit accounts are held jointly, it would be essential to establish separate credit immediately. It’s not unusual for credit access to become more difficult following a divorce as one of the spouses may not have well-established credit. If your credit score is not the best, you can start building your credit by charging monthly expenses, such as groceries, and paying the balance in full each month. By all means, don’t start accumulating a debt balance.
For many divorcing couples, the disposition of the house is one of the most significant issues. You need to consider whether it makes financial sense to keep and live in the house if that’s an option. Many times, it doesn’t. Keep in mind that, though a house is a significant asset, it can’t necessarily help you pay the bills. In fact, it can often be a financial drain.
In most cases, the spouse who wants to keep the house must be able to qualify for a mortgage on their own, which may be difficult without sufficient income or credit standing. If the divorce settlement requires one spouse to buy out the other’s share in the house, it typically requires a cash-out refinance or swapping one spouse’s share with another asset of similar value. You also have to consider the costs of maintenance, insurance, and property taxes.
The alternative is to agree to sell the house and use the proceeds to find a more suitable living arrangement. If that is the more likely case, it would be essential to search for options ahead of the divorces settlement to have something lined up.
Create a Financial Plan
Even though all your finances have yet to be settled in the divorce, it’s never too early to start planning for the future. It is strongly recommended that you consult with an independent, objective financial planner who can guide you through the process of establishing clearly defined financial goals and then mapping out a plan for pursuing them – both in the short term and the long term. This is especially important to help you stay focused as all the emotional aspects of divorce begin to cascade around you. When it comes to your personal finances, it is vital to keep your emotions out of your decision-making.
You Don’t Need to Go It Alone
It would also help to align yourself with a financial advisor you can trust—one who works with your best interests at heart. Look for an advisor who adheres to fiduciary principles to place your interests first in developing an investment strategy that meets your needs and risk comfort level.
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