Rebel Lea Robertson, CPA

What you don't know may cost you

The Financial Aspects of Divorce

Barbie never expected this to happen. Not to her. Not like this. Barbie had always thought of herself as a smart, conscientious woman who made sound, practical decisions. After all, she was the oldest child, the responsible one.  And she had two precious children – Skipper and Midge. How could this have happened? How could her marriage be ending in divorce? 

Actually, all Barbie wanted to do was hide in a hole somewhere. Everyone expected her to be somehow elated, unburdened now that she was "rid of him." So, why did se feel so confused? So unsettled and emotionally raw, how could she ever make the right long term financial decisions for herself and her kids?

No one enters into a marriage with the expectation that they will divorce, but according to the National Center for Health Statistics, in 1998 there were 2.2 million marriages and 1.1 million divorces. That translates into a 50% divorce rate. Therefore, women in one out of every two marriages will be faced with the termination of both the emotional and the financial union.

Divorce is frequently fraught with emotional pressures that leave a woman less able to cope with her future financial survival. This is a time when she needs to exercise the soundest financial judgment. If emotions are allowed to cloud her judgment, a woman may agree to a settlement that could result in a downhill slide into a severely curtailed standard of living.

The goal of any divorce should be an equitable division of property both tangible and intangible. Equitable can take many forms, though, so it is crucial that many scenarios are contemplated so that the best one can be negotiated. For example, let’s take a closer look at Barbie and Ken’s situation:

Barbie and Ken have been married for 5 years. Ken is a marketing representative for a pharmaceutical company. He earns $75,000 per year. Barbie is a volunteer and homemaker, and she needs to complete 1 year of college before she can earn her degree in finance. When they were first married, they purchased a lot for $10,000 where they had hoped to build a dream home. The current value of the lot is now $55,000. Barbie has an IRA totaling $15,000, and Ken has a 401k totaling $40,000.

Ken has proposed the following settlement:

Ken feels that Barbie could sell the lot, using the money to finish her education and support herself during the process. On the surface, this appears to be an equitable settlement. But, when Barbie sells the lot, she will recognize a taxable gain of $45,000, and be liable for taxes totaling 20% of the gain, or $9,000. Put the taxes into the equation and look at what happens:

This is a very simple example, but the point should be made that taxes can play an important part of any settlement. Quite clearly, some additional negotiation needs to take place.

Consider the example of Dave and Sandra. Dave and Sandra have been married for 12 years. They have two children, Bryan and Katie, who are 9 and 11 years old. Dave is a loan officer at a local bank, and his take-home pay is $80,000 per year. Sandra is a dental assistant, and her take-home pay is $20,000 per year. They own a home worth $150,000 that has a remaining mortgage of $100,000 with payments of $1500 per month. Dave has a 401k totaling $100,000 and Sandra has an IRA with $50,000. Sandra would like to retain custody of the children, the family home, and her IRA. Dave wants to keep his 401k and is willing to pay $500 per month in child support.

This appears to be an equitable settlement as shown below:

Based upon the proposed settlement, Sandra will barely be able to pay the mortgage. Her disposable income will be $2,166 ((20,000/12)+500). Out of that amount, she will have to pay a $1,500 mortgage payment leaving her $666 to cover utilities, groceries, repairs, clothes, etc. The expected expenses could force Sandra to cash in her IRA and/or sell the house. Again, it appears as if some additional consideration needs to be given to this situation.

Every effort must be made so that hidden assets are not overlooked when considering a divorce settlement. Stock options, deferred compensation, and uncollected bonuses, for example, are all assets that do not appear anywhere until exercised, received, or reported.

There have been many cases where these hidden assets were not discovered until after the divorce. The reasons for this can be many; including the spouse denied the existence of an asset, transferred an asset to a third party, or claimed the asset was lost.

It is important to consider the following items when a spouse suspects that there may be hidden assets:

This list is not all-inclusive, but it certainly gets the thought process started. If you are going through a divorce, it is important that you carefully consider all elements that have comprised your financial life as a couple. The process can be understandably painful at an already emotionally charged time in your life, but to insure a sound financial future for yourself and any children you may have, this analysis is critical. What you overlook may cost you dearly in the future. That is why a savvy CPA with divorce expertise can be just as essential to your final settlement as your attorney. In assembling your team of professional advisors, your goal should be to ease the financial pain of a divorce so that you like Barbie and countless other woman, can better deal with the emotional pain.