Keep an Eye on Finances During a Divorce
Six key questions to ask when dissolving a marriage late in life.
Divorce at any age will send tremors through your finances. But when it comes later in life, it's sure to upend even the best-laid financial plans.
The end of a marriage is the start of a scramble to protect your financial security. You must untangle the savings and investment accounts, real estate and other assets accumulated during your marriage. You also must update your estate plan and replace health insurance coverage that you could lose when you split from your spouse.
If you're divorcing late in life, "you may have to consider going back to work, selling your house or cashing in a life insurance policy—things you may not have intended to do," says Sara Stolberg Berkowicz, a Skokie, Ill., financial planner who specializes in divorce. To minimize the financial damage, it's vital to stay vigilant throughout the divorce process.
A growing number of older people are facing these challenges. The divorce rate among people age 50 and older doubled in the two decades ending in 2010—even as the overall divorce rate remained flat, according to a study by researchers at Bowling Green State University. One factor: Because baby boomers were the first generation to divorce and remarry in large numbers at a younger age, the study notes, a larger share of older adults' marriages are now dissolving because second marriages are even more likely to end in divorce.
The financial fallout can be devastating. Older people living alone after a split lose the safety net of a spouse's income as well as the economies of scale that come from sharing household expenses. A late-life divorce can be particularly hard on women, who are more likely to have spent years out of the workforce. That makes it tougher to find a job with enough income to sustain them through a longer life expectancy. While men's household income falls more than 20% after a divorce, women's falls 41%, according to a recent report by the U.S. Government Accountability Office.
The bottom line: For late-life divorcées, the split tends to be "the largest financial transaction of their lives," says Justin Reckers, chief executive officer of Pacific Divorce Management, in San Diego. Here are some key questions to ask before, during and after a divorce proceeding, so that your financial security lasts long after your marriage ends.
Where's the money? Before you can begin to divide your marital property, you need to know what that property is. Marital property includes the money you or your spouse earned during the marriage and the things you purchased with that money. (Generally, property you brought into the marriage or inherited is considered separate property and won't be divvied up in the divorce, although state laws differ.)
Taking stock of your property may seem straightforward. But even financially savvy spouses can easily overlook assets. Did your spouse have a pension plan at that small employer he left 20 years ago? Has a self-employed spouse overpaid estimated taxes in the year leading up to your split, hoping to quietly pocket a sizable refund? "When I got divorced, there was a bank account I didn't know anything about," says Cindy Conger, a wealth manager in Little Rock, Ark. "And I was the one who handled the finances. That was a shock to me."
Another easily overlooked asset: capital-loss carryforwards. You can deduct up to $3,000 of net investment losses per year, and losses above that amount can be carried forward and used to offset taxable gains in future years. "I've seen quite a few older couples come through in the last five years who made the mistake of selling everything at the bottom and taking huge capital losses," Reckers says. "And if you don't divide those in the settlement, one person will not get the benefits of those tax-loss carryforwards."
Collect tax returns, pay stubs, property deeds, vehicle registrations, insurance policies, account statements and even frequent-flyer and other awards-program documents. To size up liabilities, collect credit-card statements and loan documents, and order a free credit report at www.annualcreditreport.com.
A financial planner can help. A certified divorce financial analyst must have three years of related professional experience and meet certain examination and continuing education requirements. To find an analyst near you, go to the Web site of the Institute for Divorce Financial Analysts at www.institutedfa.com.
What are the tax consequences? A settlement that seems fair at the time of divorce can feel deeply inequitable a few years down the road if you don't factor in future tax bills.
Consider a $100,000 Roth IRA, which allows for tax-free distributions in retirement. It may be worth far more than a $100,000 brokerage account full of appreciated securities, says John Sweeney, executive vice-president of retirement and investing strategies at Fidelity Investments. "Understanding the tax status of assets in the accounts is incredibly important because that's really your purchasing power," Sweeney says.
Rather than giving one spouse a Roth IRA and the other a 401(k), older couples might want to divide each account between the spouses, says Barbara Shapiro, a Dedham, Mass., planner specializing in divorce.
Another tax factor to consider: Alimony is taxable to the recipient, and tax-deductible for the payor. If you're receiving alimony, you may want to have more money withheld from your paycheck. Also consider whether an alimony check may bump you into a higher tax bracket or even make your Social Security benefits taxable, says Lisa Greene-Lewis, lead certified public accountant at TurboTax.
How can we split our retirement savings? Moving IRA assets between divorcing spouses is relatively straightforward. One spouse can write a letter authorizing his IRA custodian to transfer money directly to an IRA for his former spouse. The transfer will be tax free if done under a divorce decree. Just "make sure it's direct from the custodian of one IRA to the other, and don't touch those accounts," which could cause the IRS to consider it a taxable distribution, Berkowicz says.
Dividing 401(k)s and defined-benefit pension plans can be more complex. You'll typically need a qualified domestic relations order—a state-court order that must be drafted by a lawyer, approved by the retirement-plan administrator and signed by a judge.
Because a delayed and poorly worded QDRO can cost you big bucks, it pays to get your QDRO started early and monitor its progress. In the case of pension plans, for example, "time and again we've heard from women whose lawyers did not know to ask for survivor's benefits," says Karen Ferguson, director of the Pension Rights Center, so the pension payments stop when the ex-husband dies. Another problem: A divorcing woman's QDRO fails to mention special early-retirement benefits, which allow her ex-husband to retire early and still get a full pension. "If she doesn't know to ask that the court order include this eventual right for the enhanced benefit, she won't get it," Ferguson says.
It can pay to find a lawyer specializing in pensions. Find pension counseling projects and legal service providers offering free assistance in your area at the Pension Rights Center's www.pensionhelp.org.
Nancy Keeling Davis, 63, has seen the advantages of doing your benefits homework during a divorce—as well as the price to be paid when you don't. Her 33-year marriage, which ended in 2005, spanned all but six weeks of her former husband's 25 years in the Army. She now gets 50% of his retirement pay.
But many military ex-spouses aren't receiving a portion of the servicemember's retirement pay simply because they don't know they may be able to get it, Davis says. She now works for Ex-Partners of Servicemembers for Equality (www.ex-pose.org), a nonprofit organization that provides information to people facing divorce from a member of the military. "At least 35% to 40% of our membership falls in the category of a late-in-life divorce, where the retirement benefits are of the utmost importance," Davis says.
Some benefits, including some state retirement plans, can't be divided—and "you need to make sure you get alternative property," Ferguson says.
Should I keep the house? "The biggest mistake women make is they want to keep the house," Conger says. It's often "a very bad move, especially if they give up other assets in exchange for the house," such as a pension that could provide lifetime income, she says. Shapiro says she often tells older divorcées to sell the home, split the proceeds and consider renting instead.
Laura Macy, a 63-year-old writer and actress in Kettering, Ohio, hoped to keep living in her house after her divorce. Hurricane Floyd struck her New Jersey home in September 1999, two weeks before her divorce was finalized. "The patio furniture was blowing around into the pool," she says. Considering that she'd have to pay for repairs and maintenance on a reduced income, she knew that she couldn't keep the house. "I said, 'When that gavel goes down, this thing is going,' " she says. She sold the home that she received in the divorce settlement and moved to a townhouse. She later relocated to Ohio to be near family.
Some planners suggest, however, that divorcing couples can keep the family home for a few years after the divorce and still preserve the tax advantages of selling the home as a couple. Married couples can exclude from capital-gains tax the first $500,000 of gains on the sale of a primary residence, compared with $250,000 for singles. Recent empty-nesters, for example, might co-own the house for several years so that the kids have a place to visit during the summer, Reckers says. Even if only one ex-spouse lives in the home during those years, they can still get the $500,000 tax exemption when they sell the house—as long as the sale is part of the divorce agreement, he says.
Will I still be insured? In years past, fear of being denied health coverage on the individual market overshadowed many divorce cases, leading some couples to avoid divorcing altogether. The Affordable Care Act should ease health-coverage concerns for many divorcing spouses. Under the new law, insurers can no longer deny coverage or charge people more based on preexisting conditions. Divorcées who would have relied on pricey COBRA coverage in the past may also find that marketplace coverage is a cheaper option. COBRA allows you to continue on your spouse's employer health plan, but you must pay the employer's share of the premium as well as your own (plus a 2% administrative fee).
You're generally eligible for COBRA for up to 36 months after a divorce. You must notify the plan administrator of your need for coverage within 60 days of the divorce becoming final.
If your divorce settlement stipulates that you'll be covered by your ex's health plan until age 65, sign up for Medicare when you're initially eligible to avoid a lifetime late-enrollment penalty.
You may be eligible for free Medicare Part A based on your ex-spouse's record if you don't have a long enough work history to be eligible for Social Security benefits. You may qualify if your marriage lasted at least ten years, you're single, and your ex is eligible for Social Security retirement or disability benefits. Part A pays for inpatient services.
Older couples should also pay special attention to long-term-care insurance before the divorce is finalized. If you don't have a long-term-care policy but are considering buying one, "you definitely want to buy it as a couple," says Jesse Slome, executive director of the American Association for Long-Term Care Insurance. That way, you can get a marital discount and take advantage of unisex rates, whereas women buying policies on their own can be charged higher premiums than men. Typically, spouses do not lose the marital discount when they divorce, Slome says.
If you already have a policy with a "shared care" rider that allows one spouse to tap into the other's benefits, you can remove the rider—and reduce your premium. The riders typically add 10% to 15% to the premium, Slome says.
How should my estate plan change? You should start updating estate plans as soon as you see a divorce looming on the horizon—otherwise, it may be too late.
While some state laws aim to protect people from accidentally leaving property to an ex-spouse—such as by automatically removing an ex-spouse as beneficiary of a life insurance policy after a divorce—those protections generally kick in only when the divorce is final, says Gerry Beyer, law professor at Texas Tech University School of Law. "There's no protection if you're going through the process of divorce" when you die—having not yet updated your estate plan, he says.
When you see the split coming, consult with a lawyer about updating your will and review beneficiary designations on retirement accounts, bank accounts, life insurance and annuities. Depending on where you live, automatic restraining orders may prevent you from making certain estate-planning changes once the divorce is filed. If you’ve created advance-planning documents, such as powers of attorney for health care and finances, those need to be updated, too.
After the divorce is final, review your estate plan again and make any needed changes. Contradictions between your beneficiary designations and divorce decree can create legal headaches—and in some cases, your beneficiary designations can supersede provisions in your divorce settlement.
Haven’t yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger’s Social Security Solutions today.