Financial Bear-Traps in Divorce

August 18, 2014

Divorce is one of those life-events that can have significant effect on your near-term and long-range finances.  Not only is the separation of income and assets, creating two new households and the variety of adjustments and transfers trouble enough for most people, but the pitfalls involved could be significant if you’re not careful.

One trap could exist with the family residence.  If one spouse, (say the husband), quit-claims the deed on the house over to his ex-wife, but she is unable or not required to refinance the mortgage and get the husband’s name off the loan, he is still liable for the debt against it. Any problems or default on the loan could legitimately affect his credit.  Similarly, the spouse remaining in the marital home may be wholly unable to afford the expenses of remaining there, even with mandated child support and (temporary) alimony.  Later, there could be a nasty capital gains tax if the gain over cost basis is more than $250,000, even as a primary residence.  Similarly, divorcing couples who need to sell investment property as part of the divorce agreement may run into even nastier depreciation recapture taxes.

Liquidity and cash flow are another frequent problem. Does either spouse have enough liquid assets to cover income shortfalls?   What if they overspend their income just to pay the bills?  Invading retirement assets could not only create more and unnecessary) federal and state income taxes, but if withdrawal is before age 59 ½, there are additional penalties to pay as well.

Mistakes are often made by not updating beneficiary designations after the divorce is final.  With one situation we encountered, a divorced woman had failed to change the beneficiary on a substantial medical lawsuit annuity from her ex-husband to her siblings.  When she died unexpectedly, guess who got the remaining money?  Not the sibilings.  They were extremely unhappy about the situation but there was nothing they could do.  Similar problems occur in life insurance policies.  Do you really want your ex getting a big payout if you don’t come home one day?

All of these point to the need for a full understanding of the financial aspects of your divorce.   The money saved in avoiding critical mistakes in the long-run could make the difference in whether your final settlement works – or it doesn’t.  If you don’t know the financials, consider adding a financial professional to your divorce team.