Divorce can derail your finances. Here are some money mistakes to avoid
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Money matters are often at the center of divorce disputes, good or bad.
If you are in the process of separating or considering separating from your spouse, be aware that besides the divorce price – the median is $ 7,500 per legal website Nolo – there are other parts of the process that can end unexpectedly costing a spouse.
Ideally, you have an attorney and a financial advisor to stand up for you. Regardless, experts say, it is crucial that you understand the implications of all money-related decisions.
“Take a deep breath so you can really understand your options,” said certified financial planner Danielle Howard, director of Wealth By Design in Basalt, Colorado.
“Once the ball starts rolling and all the emotional stuff is in the foreground, the financial side can be tough to deal with,” said Howard, who recently finalized her own divorce after 28 years of marriage.
Your biggest advice?
“Do your homework,” said Howard. “Find the right team to walk you through the technical, financial and emotional side. It will all feel like a hassle, but you will get it.”
Here are some common problems.
Not all assets are created equal
Some assets seem to have the same values. However, when you factor in taxes, they may not look the same anymore.
“Hundred dollars in cash are different from [a stock] worth $ 100, “said CFP Lili Vasileff, president of Wealth Protection Management, Greenwich, Connecticut.
“The sale of this stock has tax implications,” said Vasileff, who is also a certified divorce finance analyst.
Basically, the gain on a given asset – the difference between the cost base (generally what you paid) and the selling price – is taxed as either long-term or short-term capital gain after the sale, depending on whether the asset was under or over held for a year.
Hundred dollars in cash are different from [a stock] worth $ 100.
President of Asset Protection Management
“Even if two assets are currently of the same value, the cost base for them may be different and one has more or less taxes than the other,” said CFP Sallie Mullins Thompson, director of her New York company of the same name.
“Subtract those taxes from value if you really want a fair split,” said Thompson, who is also a CPA and certified divorce finance analyst.
For example, if the asset in question is a traditional 401 (k) account, withdrawals will be taxed at normal income tax rates.
“I want my customers to get a discount on the 401 (k) because they pay tax when they take it out,” Thompson said.
If you have a 401 (k) or other company retirement account and your prospective ex is entitled to a piece, be careful how you arrange the split.
“I see some people take the money out of a 401 (k) and then give it to the spouse,” Thompson said. “If they do that, there will be a 20% tax withholding.”
If the account holder is under 59½ years old, a 10% early withdrawal penalty may apply.
Instead, you need an attorney to prepare what is known as a Qualified Domestic Relationship Order (QDRO). This is independent of the divorce settlement although it is based on the content of this decree. It is also approved by the court and sent to your 401 (k) plan administrator (who will also have to fix it). And if more than one workplace account is split, a separate order is required for each account.
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There are several ways your ex can get their share of the 401 (k). Both must be specified in the QDRO. The first is via a trustee-to-trustee transfer to a rollover IRA that is not taxable on any of you.
Alternatively, some ex-spouses have the QDRO determine that they should receive 401 (k) funds directly from the plan. If this route is chosen, the recipient will not pay a 10% early withdrawal penalty, but normal income taxes will be payable on any amount that does not contribute to a rollover IRA within 60 days.
Although a QDRO is not required to split an IRA, you still need to perform a trustee-to-trustee transfer with funds transferred to a rollover account for the recipient, Thompson said.
Also, make sure the divorce ordinance (and QDRO) shows that percentage instead of a dollar amount if it is intended that each spouse will receive 50% of the assets of a retirement account, for example.
Here’s why: let’s say there is $ 100,000 in a 401 (k) and the non-account holder gets 50%. If the QDRO states that the receiving spouse should receive $ 50,000 – which was 50% at the time the order was placed – and the account records any gains or losses prior to the transfer, then $ 50,000 is no longer 50%.
The family house
Sometimes divorced couples sell the family home and divide the proceeds as prescribed in their agreement.
In other cases, one of the spouses stays in the house. In this situation, there are a few things to consider, depending on the particularities.
For starters, you would need to refinance the loan and qualify for it yourself, assuming your ex is no longer a co-owner or responsible for a mortgage on the home.
However, at the time of the property appraisal during the divorce talks, make sure you get an appraisal – and determine the property’s cost base. Once it is in your name only and at some point you sell it, you will be solely responsible for paying capital gains taxes on profits that exceed the current exclusion of $ 250,000 per person.
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“If you sold it while it was in common name, you would get the higher exclusion [for married couples] of $ 500,000, “said Vasileff of Wealth Protection Management.
There are several other difficult situations that can result in greater capital gain than expected.
For example, if you and your spouse bought your current home prior to 1997 when the tax laws were different, chances are that deferred profits from another home sale could be included in the purchase, Thompson said.
If so, the cost base of the property being valued in the event of a divorce must be reduced by the amount deferred, she said. This generally translates into a higher profit on sales.
Another difficult situation: if the outgoing spouse used a home office, which resulted in a home depreciation during that period (for tax reasons), the cost base needs to be lowered to reflect this amount. Again, this would generally result in a greater profit from the sale of the property.