As a divorce attorney in Charleston, South Carolina, our law firm has handled cases both big and small where the parties had millions in assets or the parties were in a financial crisis and behind on their mortgage and credit cards. No matter what financial situation you’re in, the results are the same – you take one household, you split it in two, and you double living expenses. What that means is that your lifestyle is altered, and you need to change your spending habits during and after your divorce. In this article, I detail 6 steps you need to take to plan financially for your divorce such as identifying your assets and income, creating a budget, and more.
Step One – Identify All Assets and Income
In another post, I explained what you need to do if you believe your spouse is hiding income or assets during your divorce. I encourage you to read the tips I gave for protecting yourself from a dishonest spouse and how to avoid being falsely accused of hiding money and property.
Although your assets, such as cars, furniture, your home, and so on, may have value, some assets are easier to convert to cash than others. Assets that are in the form of financial accounts (checking, savings, brokerage accounts, etc.) are very liquid. Furniture, land and homes, antiques, and other items have value too, but they aren’t easily sold and converted to cash. So, on paper, it may look great to keep a home and its value while your spouse takes the brokerage account, you need to consider your cash flow and your ability to pay living expenses such as maintaining the home. In the end, you don’t want an unbalanced divorce settlement where you end up with non-liquid assets and no means of paying for your lifestyle.
Step Two – Create a Budget
Because your post-divorce income (and your lifestyle) are likely to change (in some cases dramatically), you need to create a budget. Budgeting requires that you know your monthly spending needs and your current spending habits to track your cash flow. Your budget should account for your projected disposable (after-tax) income, consider liquid assets, and take into account non-liquid assets that will incur ongoing costs such as maintenance on a home.
Not everyone can afford the services of a Certified Divorce Financial Analyst (CFDA) to calculate your needs into the future. If you are going to consider your finances yourself, then you need to collect all your bills, financial statements, credit card statements, checkbook registers, and receipts for things that you buy with cash to create a good record of your income and expenses. Next, you’ll need to categorize your monthly income and expenses. Here is an example of those two categories:
Expenses: Rent or Mortgage; Property Insurance; Property Taxes; Gas; Electric; Phone and Cell Phone; Cable; Water and Sewer; Trash; Internet; Groceries; Eating Out; Daycare; Camps; Kids’ Lunches; Extracurricular Fees; School Photos; Allowances; Office Supplies; Bank Fees; Credit Cards; Bank Loans; Auto Loans; Auto Insurance; Car Care; Road Tolls; Doctor Bills; Dental Bills; Eye Care; Repairs; Gifts & Cards; Cleaning and Household Supplies; Clothing; Personal Grooming; Pet Care; Magazines and Newspapers; Health Insurance; and Life Insurance.
Divide your spending into fixed or variable costs. Fixed costs include mortgage payments loan payments, rental payments, and so on. These aren’t expenses that you can easily reduce or change in your budget. Variable costs such as clothing, food and entertainment, cell phone usage, and so on can be reduced or, in some cases, eliminated from your budget.
Income: Wages and Salary; Business Income; Rental Income; Pension; Alimony; Investments and Interest; and Child Support (although this isn’t considered income for tax purposes, it should be part of your budget).
Don’t count on bonuses, tax refunds, etc. because these sources of income are highly variable and oftentimes unpredictable.
After you have created your monthly budget, it’s time to set your budget goals considering your income and liquidity of assets that can be used to pay for your lifestyle now or in the future. If you need to trim your expenses, look over the categories of variable expenses for things such as the cost of premium cable channels, caller ID and call waiting on your home phone, how often you eat out, using ATM machines that charge fees for cash withdrawals, and so on. You may be surprised at how much you’re spending at Starbucks, eating out for lunches, and other personal expenses that add up to thousands each year. Also, try to pay your bills as soon as they are due. Late fees and penalties will derail your budget.
Step Three – Consider Tax Consequences and Liabilities
You need to consider capital gains (and alimony, which is taxable). Simply stated, capital gains are calculated by the asset’s fair market value minus its cost. For example, if you purchased an asset for $20 and it is now worth $200, then your capital gain is $180.00, and tax liability is on that amount when you liquidate the asset. Why is this important? Suppose you and your spouse have two pieces of land, both of which are equal in value, but one of which was purchased at a very low cost which may result in large capital gains. If you receive the one that is facing more capital gains, then the net benefit to you is lower than if you received the other piece of land.
Also, you need to consider any tax liabilities. For three years after the divorce, the IRS can perform a random audit of a divorced couple’s joint tax return. For good cause, the IRS can question a joint return for up to seven years. Your divorce agreement should have provisions that decide which spouse is responsible for any additional penalties, interest, or taxes.
Step Four – Consider How to Transfer or Liquidate Retirement Accounts
Prior to age 59 1/2, retirement plan distributions are subject to a penalty tax plus ordinary income tax. An exception to the tax penalty is transfers of all or a portion of a retirement plan to a spouse as part of a divorce settlement. Income taxes still apply, so any assets you receive from a “qualified plan,” such as a 401(k), are subject to a mandatory tax withholding. To avoid this mandatory withholding, the transfer must be made directly to another retirement account, such as your own IRA. If you need to cash out on some of the plans, take them out before your spouse transfers them to your IRA to avoid the penalty tax for early distribution.
Step Five – Consider Your Credit
To avoid starting out with bad credit after your divorce, there are several steps you need to take. Get a copy of your credit report to identify all joint accounts and items that show up on your report that may impact your credit rating. Even if the family court makes your spouse responsible for paying a joint debt, such as a credit card, you are still liable to the creditor (that wasn’t part of your divorce) for the full amount until the debt is paid off. So, to avoid liability and the possibility of a bad credit rating if your spouse fails to pay the debt, you should pay off and close all joint accounts before the divorce settlement and open new accounts in your name.
Step Six – Obtain Life Insurance
If your spouse is paying alimony, child support, or some other form of support, then it’s a good idea to insist that your spouse obtain life insurance to cover these ongoing payments in the event of a tragedy. If you’re the beneficiary of this insurance is obtained, then it is very important that you be deemed the owner or irrevocable beneficiary of the insurance policy. That way, if your ex stops making payments for some reason, you’ll be notified so that you can take legal action to prevent the policy from lapsing or being canceled.