Tips for avoiding common financial mistakes in a divorce

Tips for avoiding common financial mistakes in a divorce
Tips for avoiding common financial mistakes in a divorce

In this 1st part of 2 part post, here are some tips for avoiding common financial mistakes in a divorce. Getting a fair settlement is easier to do if you avoid these mistakes.

Many couples face financial uncertainty after they divorce. This is often the result of using the same income to pay expenses to operate two households instead of one. For instance, you’re now faced with two mortgage or rent payments; utilities, furniture, appliances, and supplies for two homes… The expenses add up.

If only one ex-spouse works outside of the home, then he or she may have to pay both spousal and child support, which will negatively affect the payor’s cash flow. If both spouses work outside of the home, then each would have only a portion of their combined income to use to pay for their individual household expenses.

Separation or divorce is a time when both of you should reduce your spending and make an effort to live within your individual means. For instance, if you’re not working, can you really afford the country-club dues or fresh flowers every week?

One common pitfall is considering the assets that you receive as part of the property settlement as an additional source of income. Instead of using these assets to pay for current expenses, they should be maintained for emergencies, retirement, creating new sources of income, and other long-term financial goals.

This does not mean that you should never touch these assets: it’s one thing to use them to pay for tuition to improve your job skills, but quite another to deplete them to purchase a brand-new SUV. Before you dip into these assets, ask yourself whether the expenditure is going to create income for you in the future, or whether it’s a frivolous purchase you’re going to regret when the bill comes due.

 Not all Assets are Equal

When you are deciding on what assets you and your spouse will take, you should be aware that not all assets are equal. One of you may end up with a huge tax bill when you access the assets: for instance, you could end up paying capital-gain taxes upon the sale of your home or your investment assets. In addition, if you dip into your retirement assets, you may end up paying income tax and a penalty. In the example above, Lisa paid taxes and a 10% penalty in the U.S. every year that she dipped into the retirement account.

Other assets may end up being a money pit. Your primary residence, vacation home, or rental properties could cost you a significant amount of money to maintain. Frequently, the primary benefit of a rental property is not necessarily cash flow, but the tax losses that are generated. If you are in a low tax bracket, then these losses may not benefit you to the extent that another investment would. Your expenses may actually increase. For example, if your spouse used to make all repairs, mow the lawn, etc., but now you have to hire someone to do those things, then your expenses will increase. Would you be better off liquidating these properties and investing the proceeds in something that would increase your cash flow instead of creating a financial drain?

 The Family Home

Reducing expenses may mean selling the family home and downsizing to a smaller home. In the example above, did Lisa really need the million-dollar family home? In this case, “keeping up appearances” cost her a comfortable future. If she had sold the house at the time of her divorce, she could have increased her cash flow in two ways: decreased costs, and additional funds to invest. The costs to maintain her home – such as property taxes, utilities, maintenance, and repairs – would have decreased in a well-maintained but more modest property. In addition, since there was no mortgage on her home, she would have been able to buy a smaller home free and clear and still have funds left over to invest and increase her cash flow.

Her choice to keep the house also meant that she was hit with all the capital-gains tax from the time she and her ex-husband bought the house in 1975 to the time she was forced to sell it. The house had appreciated significantly in value over the years, so after paying her tax bill, she was left with a much smaller nest egg than she had expected to help her start over.

Choose Your Battles

You can go broke during property division if you insist on fighting over every last item. During her marriage, Mary purchased a leather desk-accessories set that included a matching leather wastepaper basket. Her husband Larry wanted the wastepaper basket, but she insisted that the set would be incomplete without it, so they ended up fighting over it. After spending in excess of $5,000 in attorney’s fees, Mary ended up with the wastepaper basket. Does this sound too ridiculous to be true? Be warned: this kind of thing happens every day in divorce court. Emotions are running high, and some people will fight “to the death” over truly trivial items. Sometimes, they’re more concerned with making sure their ex-spouse doesn’t get something than with actually getting it themselves.

You have to look at the big picture. Is this item really worth fighting over? Can you purchase a new one for significantly less than you will spend in attorney’s fees? Not only are you wasting money, but you are also increasing the ill-will between you and your soon-to-be ex. If you have children, this can take an emotional toll on them.

Here’s a hard truth for you: no one gets everything they want in a divorce settlement. You will have to give up some possessions you really like – maybe even some heirlooms – so prepare for this by creating a short list of “Must-Haves,” a longer list of “Would-Like-to-Haves,” and a third list of “Don’t-Wants.” Don’t tell your ex you don’t want the items on this third list; instead, “gracefully” offer to trade them for the items you really want. Be prepared to give up some of your “Would-Like-to-Haves” in exchange for more of your “Must-Haves.”

In this 1st part of 2 part post, here are some tips for avoiding common financial mistakes in a divorce. Getting a fair settlement is easier to do if you avoid these mistakes.  Still have any questions or concerns?  Call me!  No charge for the initial consultation.