Divorce is commonly seen as one of the most stressful experiences one will ever go through. Along with all of that stress, you are also making financial decisions that will most likely affect the rest of your life and perhaps the lives of your children as well. For that reason, it’s always a good idea to get the advice of a Certified Divorce Financial Analyst™ or some other financial professional during your divorce process. Having another set of eyes on your situation is always a good idea. Your attorney will give you advice on your legal rights during divorce, but your financial professional looks at asset division in a whole ‘nother way.
Here are the first 3 of 6 most commonly overlooked financial issues I’ve seen in divorce cases over the years:
1) Handling of the Term Life Insurance
In a 2018 Insurance Barometer Study, by Life Happens and LIMRA, ONLY 59% of Americans have some form of Life Insurance. That’s a sad statistic considering everyone could benefit from some form of Life Insurance, even if it’s Term Insurance. “Term Insurance” is the kind of insurance that only last for a certain ‘term’ or period of time. 10-year term and 20-year term are some of the common terms that I see. In some cases, a couple going through a divorce might already have a term policy that they purchased when the kids were born. Usually consisting of just enough insurance to get them through college if something were to happen to one of the parents, most likely the high-income earner. Because term policies don’t have any cash value, I’ve seen them completely ignored during the divorce settlement and if they are addressed, the decree might say that the insured is ‘required’ to keep their spouse as the beneficiary. However, a piece of paper that requires someone do something doesn’t actually keep them from doing it. The high-income spouse might remarry down the road and five years from now find themselves in an insurance review with their new spouse where they find out the old spouse is still listed as the beneficiary. Forgetting why that was the case, or that they are ‘required’ to leave it that way, they change the beneficiary, and nobody finds about it until policy holder passes away.
In a collaborative divorce, the spouses can request that the insurance company change the ownership of the policy to the beneficiary, thereby making the beneficiary the one in charge of who the beneficiary will actually be. Something they will most likely never change. The trick is that this request must be made while the parties are still married.
2) Forgetting the Tax Effect of 401k Money
Let’s say that a couple is getting divorced and they only have two assets. A 401k worth $200,000 and house with $200,000 in equity. In a Kitchen-Table style divorce, where a couple sits at their own kitchen table and figures out their own divorce, it might seem fair for one spouse to take the 401k, and one spouse to take the house. After all, they are both worth $200,000, right? Well, that is rarely the case. Consider this. If the spouse taking the 401k has not worked in many years, and I’ve often seen clients who have been out of the work-force for over 20 years, if they take the 401k, but it is known that they are going to have to live out of the 401k for a few years while they get themselves back to work, then they are going to have pay income tax on any money that they pull from the 401k. Assuming they pull $50,000/year for expenses, they will pay over $8,000 in taxes each year. Should they bear the burden of all of those taxes? Probably not. If this couple had used a financial advisor during their divorce, it would have become obvious that the two assets were not of equal value.
Now assume for a second that the spouse who took the house was not planning on keeping the house. If they were planning on selling it, they would end up paying a percentage to their agent and perhaps even more to get the house ready to sell. Their net at the end of the day would not be $200,000, but something less.
In a Collaborative Divorce, it’s customary to have a financial person on the team who can calculate the estimated net value of the 401k and the estimated net value of the house and come up with a division of the assets that is fair.
3) Valuing a Pension
While pensions are not that prevalent these days, they are still common for School Teachers and Government Employees. Every participant who is enrolled in a pension gets a statement showing them what dollar amount they could access if they cashed in their pension. This dollar value is NOT the value of the pension. It’s simply their walk-away value. A professional pension valuation would need to be done in order to calculate what the actual value, in today’s dollars, is. To do this, we need a few bits of information. The hire date, the marriage date, the separation date, and the last day of employment, if employment has been terminated. That information will tell us how much, if any, is community property and how much, if any, is separate property. We would also need to know when the employee is entitled to start receiving monthly payments and what would those monthly payments be and is there a cost of living adjustment.
Next, we would need to know what growth value we are going to use to calculate the present value. In other words, we are calculating how much money one would need to have invested today, at the given growth percentage, to create a pool of money that would generate the same stream of payments at some point in the future. The most commonly used return percentage would be the 20-year treasury. Currently, that figure is 2.65%. The smaller that number then the larger the valuation will come out to be, but it is usually significantly more than the figure on the employee’s statement. Failure to accurately calculate the true value of the pension can have a significant effect on the asset settlement. It’s always a good idea to have a financial professional involved in your divorce so that these issues are not overlooked.
Check out next month’s blog on 3 more commonly overlooked financial issues of divorce.
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