Divorce and Retirement: 5 Financial Pitfalls to Avoid
|May 12, 2019||Posted by Marcia Mantell under For Women|
Divorce is an emotional, financial, and draining process. Add to the mix that the tax rules for alimony payments changed after almost eight decades as of January 2019. This rocked the boat for many divorced or divorcing individuals. For those who are dealing with divorce and retirement, it may be helpful to recognize and avoid five financial pitfalls.
Some Facts about Divorce and Retirement
Not surprisingly, 98% of people receiving alimony checks are women, according to the US Census Bureau. In most families, even today, women are or have been the lower wage earners. As a result, they tend to be the recipients of alimony. Furthermore, women tend to be the primary caregivers for the children. So, it is no wonder, then, that of those receiving child support, 92% are women.
There has been a fair amount of news the past few years about “gray divorce.” The Pew Research Center reports that as of 2015, those age 50 and older have experienced an increase in divorce. Here are the latest stats:
- For every 1,000 married individuals, 10 were divorced. That is twice as high as the number of divorced individuals in 1990.
- The number of Boomers getting divorced as they approach retirement is considerably smaller than those in their 40s. As of 2015, forty-somethings divorced at a rate of 21 per 1,000 married persons.
- For individuals 65 and older, the rate was six divorced individuals per 1,000 married individuals.
Among those 50 and older, about one-third divorced after long-term marriages—married at least 30 years. Another 12% were married for 40 years or longer. While being free and independent is a defining characteristic of the Boomer generation, divorce and retirement often don’t mix.
5 Common Pitfalls when Balancing Divorce and Retirement
While going through the divorce process your goal is to balance both divorce and retirement needs and come out as financially intact as possible. To help keep you on track, take a look at five common pitfalls individuals stumble into during divorce. You may find the suggestions helpful along your journey.
1. Not hiring an expert divorce attorney.
Plain and simple, it’s critical to hire the best divorce attorney you can. This is not the time to hire your “friend-the-attorney”, or to skimp on paying for top-notch divorce counsel. No one wins financially in a divorce. It’s imperative that you protect your financial and retirement future with the best possible attorney who will advocate for you.
Interview several attorneys and their staff until you are comfortable with your choice. You want to be able to work with that person’s style and like how they communicate with you. Plus, the administrators and backup lawyer(s) may end up very involved in your case. Your pick should have years of experience. After all, what you are really paying for is their expertise and advice to navigate you through uncharted and sometimes treacherous waters.
The communications throughout the process must be a two-way street. You may have to do some research about your soon-to-be-ex’s situation and will bring your findings to the table. Your attorney will bring his or her expertise. In the end, you’ll want to do what your lawyer advises you to do, but include the information you are contributing on your own behalf as well.
It can be hard to be objective and control your emotions during a divorce. Be confident your divorce attorney will have your back and protect your interests.
2. Failing to understand tax implications of alimony.
For decades, the payment of, and receipt of, alimony has had distinct tax consequences to each divorced individual. Prior to the beginning of 2019, the party paying alimony received a tax deduction, and the recipient had to pay income tax on the alimony amount.
Effective January 1, 2019, the current tax law reverses these age-old tax arrangements and now:
• the person paying alimony does not receive a tax deduction;
• the person receiving an alimony payment does not declare it as income.
What’s behind this tax law change? The issue debated in Congress has been the following: It’s generally the higher earner who pays alimony, so he, in most cases, is in a higher tax bracket. He received a tax deduction, and it was often a significant amount. The receiver, usually the wife and mother, is generally a lower earner and in a lower tax bracket. While she ends up paying tax on the income, it’s at a lower tax rate.
As a result, if the alimony payment is, say, $30,000, fewer taxes were paid on that money than if the couple were still married. Many in Congress considered this a “divorce subsidy”.
Saving for Retirement May Be More Challenging
It’s fair to say that many payers will be upset by this arrangement. They feel they are getting the short end of the stick. Bearing the brunt of higher tax liability could impact their ability to save sufficiently for retirement.
On the other side, the party receiving alimony may now receive a smaller alimony payment. This, too, puts the recipient in a challenging position for saving adequately for retirement.
You can see how financially difficult divorce can be for both parties. Neither feels the financial split has been equitably handled. And, the implications are on current income and future retirement needs.
3. Delaying hiring your financial team.
There are three financial experts you’ll want in your corner while going through a divorce and when you are rebuilding after the dust settles.
Unless you are a CPA or a tax guru, hire a great CPA.
He or she will bring expertise about the numbers to the forefront of your divorce planning. Your accountant needs to run the numbers specific to your exact situation and consider several possible outcomes. They can’t simply “eyeball” it and estimate what will happen with your taxable assets and retirement savings.
Your financial team will help you determine and achieve your financial goals.
Your team includes a financial planner, an investment advisor, and an insurance agent to help with both divorce and retirement decisions. You’ll have a lot of balls in the air as you build your new life. Make sure your money is being managed well, the proper beneficiaries are in place, and everything from your home, auto, and life are protected.
An estate planning attorney.
It’s more important than ever to get your estate and health care documents in place. Even if you had an estate plan as a married person, you’ll need to create new documents and possibly name new people to make decisions on your behalf. State rules change frequently, so make sure you are up-to-date with your estate plans.
One additional team member you may find helpful: a counselor or social worker. While they are not directly “financial” advisors, having a confidant in your court may be a critical resource. You’ll be dealing with a myriad of financial decisions coming at you at a most vulnerable time. Many people going through a divorce find it helpful to have a safe outlet to express anger, frustration, or fear. Once you tame these issues with your counselor, you may find yourself in a better state of mind for making critical divorce and retirement financial decisions. Plus, you’ll be more likely to tackle the to-do list from your financial advisors.
4. Thinking your retirement accounts are yours.
It’s quite obvious that a divorce means splitting up assets, perhaps selling the house, and if children are involved, helping them manage the new uncertainty in their young lives. What is not so obvious, however, is that all the money you’ve been socking away in your 401(k) or 403(b) or IRAs is not necessarily yours. Say what?
Retirement accounts are set up or “registered” as individual accounts. An IRA only carries one name per account. There are no such things as “joint IRAs”. Employer plans are also registered in just one name. It seems that your 401(k) or 403(b) is your own account. But, it’s not.
Retirement accounts are meant for the couple
During the divorce you find out that your retirement account is going to be split 50/50. Your ex is generally entitled to half of these savings. This can feel as if “your money” is being taken right from under you. It’s important to put this situation in context. Realize that when you are part of a married couple, these retirement accounts were never just for you. They were always meant to be retirement money for the two of you.
To be sure, the legal plan document that governs your retirement account is clear about that. Most plans specifically note that when it comes time to take money from that account, you must get your spouse’s signature in advance. Nevertheless, it still stings mightily to see the balance of your retirement account drop from say $800,000 to $400,000 as a result of the divorce. And, many individuals post-divorce report that it is difficult to rebuild their retirement savings. Especially if they are in their 50s or 60s and closing in on those retirement years.
One note in the cases where both spouses worked and saved for years: the retirement accounts may or may not be split. It will depend on the entire financial picture and how to equitably divvy up assets for retirement.
It is a surprise to many ex-spouses that they are eligible to claim “ex-spouse” benefits on the work record of their ex. Indeed, it’s true, but only when certain rules are met. Effectively, if you and your ex were married long enough to set up a financial household together, you are eligible to claim on each other’s earnings record as long as it would give you a higher dollar amount. (You can find more information about divorce on Social Security’s website.)
First, the Social Security rules for ex’s:
• The two of you must have been married for 10 consecutive years or longer. Not 9 years and 10 months. Not 6 years the first time, and 7 years the next try. (The one exception is if you get a divorce, decide it was a mistake and remarry the same person within 12 months of the divorce.)
• You each have to be at least age 62. So, if you are the older ex, you have to wait until your younger ex-spouse reaches 62. Each person must be eligible for Social Security retirement benefits before either one can claim on the other.
• Your divorce had to be finalized at least 2 years ago, or your ex is already claiming benefits.
• You have not remarried. If you have remarried, you are once again a spouse and may be eligible for spousal benefits on your current husband or wife.
Next, how much can you get on your ex’s Social Security record?
• The general rule is that when you reach your Full Retirement Age (between 66 and 67), and assuming you meet all other rules above, you are entitled to 50% of your ex’s Primary Insurance Amount.
• If you claim earlier than your Full Retirement Age, you’ll get less. And, it can be a lot less if you claim as early as age 62.
Is there a catch?
Well, yes. You can only claim on your ex’s record if your benefit amount is less than half of your ex’s. Here’s what I mean:
• If your own Primary Insurance Amount is $1,200 per month, and 50% of your ex’s Primary Insurance Amount is $1,000 per month, you’ll only get the benefit on your own work record. It’s the higher option.
• If your Primary Insurance Amount is $750 per month, and 50% of your ex’s is $1,000 per month, you’ll get $1,000.
• You’re only entitled to one benefit payment at a time. It will be the highest one for which you are eligible.
What about the higher-earning ex?
The higher-earning ex-spouse is often concerned that he (or she) has to give up some Social Security benefits to pay the lower-earner’s benefit. Not so. Keep in mind that Social Security is simply a series of calculations. There is nothing personal here.
If you meet the rules to claim on your ex, and you would get a higher benefit on your ex’s record, your calculated benefit will be based on your ex’s work history. Your ex’s benefit is not reduced at all. He gets his full calculated benefit, based on his work history. Multiple people can receive a benefit based on one person’s work record. The higher earner’s benefits are not reduced.
Do you have more than one ex-spouse?
What if you are the higher earner and have two or three ex-spouses? There is no impact to your benefit. Each eligible ex-spouse (as long as you were married to each other for 10 years or longer, and meet the other eligibility rules) will be eligible to receive a benefit based on your higher-earning record.
To bring this to life, let’s look at an example. If his Primary Insurance Amount is $2,600 per month, and he claims at his Full Retirement Age, he’ll get $2,600. Each ex-wife who meets all of the ex-spouse rules will receive $1,300 per month (half of his) at her Full Retirement Age, so long as this is the largest benefit each is eligible for.
The Bottom Line with Divorce and Retirement
Whether the idea for the divorce was his, hers, or both, it is a difficult journey fraught with financial landmines you might not even know are out there. Especially when it comes to securing your retirement financial assets. The right people on your side will provide expertise to help you avoid hidden dangers and pitfalls of divorce and retirement.
If you and your soon-to-be ex worked with certain financial professionals, it may be best to find a new team dedicated to just you. You may find it more helpful to choose professionals who don’t know the history of the two of you and who will have your back no matter what.
There are many financial considerations each party must take into account when splitting up a financial household during a divorce. Surround yourself with the best people on your team and take their advice. Learn as much as you can and give yourself credit for keeping all the balls in the air. Remember to ask questions and make sure your voice is heard loud and clear.
If you need information and resources to support you during a divorce, here are a few to take a look at:
Support information for women across all 50 states
Check out this site to find a certified divorce financial planner in your area
Information for dad’s who are navigating divorce in all 50 states