The latest research suggests that divorce rates in the U.S. have been falling in recent decades. Still, many people face the difficult crossroads that comes when their marriage ends.1
Getting a divorce is often a painful, emotional process. Don’t be in such a hurry to reach a settlement that you make poor decisions that can have life-long consequences. If divorce is a possibility, here are a few financial ideas that may help you prepare.
The most important task you can do is get your finances organized.
Identify all your assets and make copies of important financial papers, such as deeds, tax returns, and investment records.
Identifying Marital vs. Separate Property2
- Marital Property: Any assets acquired during the marriage, such as homes, vehicles, retirement accounts, and income, are typically considered marital property and subject to division.
- Separate Property: Assets owned before the marriage or received as gifts/inheritance during the marriage are usually separate, but there may be exceptions, like commingling funds.
Valuation of Assets
- Determining the current value of assets can be complicated. Homes, businesses, and retirement accounts all require accurate valuations. If one spouse owns a business or a professional practice, that can require a specialized business valuation.
- The parties may need to hire appraisers, accountants, or financial analysts to help in the process.
When it comes to dividing up your assets, consider mediation as a potential lower-cost alternative to litigation. Most states have equitable-distribution laws that require shared assets to be divided 50/50 anyway. When a divorce becomes contentious, attorney’s fees can accumulate.
From a financial perspective, divorce means taking all the income previously used to run one household and stretching it out over two residences, two utility bills, two grocery lists, etc. There are other hidden costs as well, such as:
- Counseling for you or your children
- Potential reduced productivity
- Attorney, Court, Mediator, Expert Fees
- The impact on tax filing status
- Health Insurance changes
- Security deposit on a rental property
- Moving costs
- Increased childcare
Dividing assets may sound simple, but it can be quite complex. The forced sale of a home or investment portfolio may have tax consequences. Potential tax liability also can make two seemingly equal assets have varying net values. Additionally, when pulling apart a portfolio, it makes sense to consider how each asset will suit the prospective recipient in terms of risk tolerance and liquidity.
Dividing Retirement Accounts
- Retirement assets (401(k)s, pensions, IRAs, etc.) are typically divided in a divorce. The division requires special documents like a Qualified Domestic Relations Order (QDRO) to ensure the correct allocation.3
- The type of retirement account, its tax implications, and whether it’s vested or not can all impact how assets are divided.
Tax Implications
- Capital Gains Tax: The sale of marital assets, like real estate or stocks, can trigger capital gains taxes, and both spouses must consider how to share these costs.
- Taxable Transfers: Certain transfers, like those involving retirement funds or real estate, can have tax consequences that should be taken into account when determining the division of assets.
- Filing Status: The IRS outlines how your relationship status can impact the way you file your taxes.4
- Spousal support (alimony) may also impact taxes. The 2017 Tax Cuts and Jobs Act eliminated the tax deduction for alimony for new divorces.5
Debt Division
- Marital debt, including mortgages, credit cards, and loans, needs to be divided fairly. Often, debts are divided based on who incurred them or the parties’ ability to repay them. In community property states, who incurred the debt may have little weight since almost all assets and all debts are evenly split.
- If one spouse agrees to assume certain debts, there may be considerations about how those debts affect other financial assets or spousal support.
During a divorce, many factors compete for attention. By understanding a few key concepts, you may be able to help avoid making costly financial mistakes.
Remember, the information in this article is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
- https://www.census.gov/library/stories/2024/10/marriage-and-divorce.html
- https://freedmarcroft.com/understanding-the-divorce-process-a-beginners-guide-to-a-smooth-transition/#:~:text=1.%20Uncontested%20%E2%80%93%20Both%20spouses%20agree%20on,an%20agreement%20in%20all%20sorts%20of%20ways
- https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/division-of-retirement-benefits-through-qualified-domestic-relations-orders.pdf
- https://www.irs.gov/individuals/filing-taxes-after-divorce-or-separation
- https://www.cbmcpa.com/2024/04/05/divorce-expiration-tax-cuts-and-jobs-act/#:~:text=Before%20the%20TCJA%2C%20individuals%20paying,finalized%20after%20December%2031%2C%202018.