The big financial decisions in life require both planning and, often, advice from professionals. However, people undergoing a divorce often go through the experience without either a safety net or an understanding of how much their lives will be affected by the decisions they make.
"People think of buying a house or putting their kids through college as the big financial decisions in life, but the biggest financial decisions people make happen when they go through a divorce," said Carol Lee Roberts, general manager of the Institute of Divorce Financial Analysts. The IDFA oversees the Certified Divorce Financial Analysts designation for financial advisors.
The divorce experience has broad and far-reaching consequences that affect the rest of an individual's life. It also has enough twists and turns that many financial advisors — particularly those focused on female clients — are getting CDFA training to help their clients through the experience.
"A divorce is the largest financial transaction in most people's lives, and it's a chaotic time for them," said CDFA and certified financial planner Justin Reckers, CEO of Wellspring Divorce Advisors. "Most financial advisors don't have experience with divorce laws, and they aren't used to dealing with emotionally distraught clients."
While divorce rates in the United States have been dropping over the last two decades, it is still estimated that between 40 percent and 50 percent of all marriages end in divorce. What's more, divorce is on the rise for Americans over the age of 50. In these so-called "gray divorces," the cost of mistakes in the process can be hard to recover from. "In gray divorces, people don't have 20 to 30 years to make up for errors," said Roberts. "The financial implications for these people are much higher."
The implications of divorce are huge for anyone going through the experience. Here are five key things to keep in mind if you reach this crossroad.
1. Get help. Divorce is one of the most emotionally charged situations a person can experience, and when people are emotional, they make bad decisions. Getting professional help in order to avoid mistakes is crucial. Any financial advisors already shared by married couples initiating the divorce process likely will have to recuse themselves, as they can no longer work in both parties' best interests.
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Women understand the importance of finding help. Avani Ramnani, CFP and director of financial planning and wealth management at Francis Financial, said about 90 percent of her divorce-related clients are women.
In part, that's because women still tend to be more negatively affected by divorce, experiencing more significant decreases in their standard of living. "In general, women are more cautious and more concerned with preserving capital," said Ramnani. "We are seeking to work more with men, but they're less inclined to seek advice in financial matters relating to divorce."
Bad mistake.
2. Insure the support payments. In most divorces where children are involved, one partner — usually, but not always, the male — provides child and or spousal support for the other. These support payments are essential for partners undertaking greater responsibility for children, particularly if they have not been earning income for a long period.
"Get insurance to back those payments up," said Roberts at the IDFA. If a supporting partner dies, the payments may cease altogether if there is no insurance policy underlying them.
For example, a $200,000 life insurance policy can backstop a 10-year settlement of $20,000 per year. Roberts also says that the receiving partner needs to own the policy so that the supporting partner can't change the beneficiary or stop paying premiums. "You can set it up so the beneficiary is irrevocable and [the supporting partner] is mandated to pay the premiums."
3. Pick your assets carefully. For a variety of reasons, the division of assets in a divorce is never as simple as it might seem. A detailed cost-benefit analysis of some assets versus others is crucial to avoiding problems down the road.
"A property division might look equal but actually not be at all equitable," said Reckers of Wellspring Divorce Advisors. For example, if one partner takes the $1 million house, while the other takes $1 million in financial assets, the long-term financial implications could be very different for the two individuals.
A common situation is the woman taking the family home and giving up the financial assets. That could result in major problems down the road.
The more acrimonious the divorce, the more money is spent on attorneys and the more the pot is diminished. We try to help people understand that from the get-go.Avani Ramnanidirector of financial planning and wealth management at Francis Financial
"Liquidity is a huge issue," said Francis Financial's Ramnani. "You could find yourself in a situation where you can't pay your bills and you're taking on the risk of the real estate market."
Financial advisors can run projections on marital assets, taking into consideration factors such as liquidity, risk and taxes to give clients a clearer picture of a potential settlement.
4. Taxes, taxes, taxes. Often overlooked in a divorce settlement are the tax implications of the asset divisions. For example, $1 million of assets in a 401(k) plan is worth far less than the same amount in a taxable account. The former will ultimately be taxed at marginal income-tax rates when withdrawn in retirement, while the latter will face typically lower capital gains taxes.
There are also major disparities in tax treatment of real estate assets vs. financial assets. Individuals don't pay tax on the first $250,000 in capital gains on a home, while couples get a $500,000 exemption.
If the family home is a large and valuable property, the tax bill could ultimately be very high on the partner who takes the house. One solution is to agree to co-own the property for a certain length of time (i.e., until the children grow up) to avoid the tax hit. "Sometimes people going through a divorce can stand to co-own property for a period of time," said Reckers.
5. Lifestyle — get ready for change. Unless you're among the very wealthy, divorce almost always results in a diminished lifestyle for both partners. The situation may be more acute for women if they have not been earning income for an extended period.
Reckers, who deals predominantly with women in his divorce practice, builds a current lifestyle budget for his clients and does projections on what they would like in the future and what they need. "Budgeting is the most important thing to consider before, during and after a divorce," he said.
In almost all cases, lifestyles have to change — and that is usually the biggest source of acrimony in the divorce process. With the same amount of income now supporting two households, something has to give. That leads to frustration, resentment and — often — very nasty divorces.
Like all financial advisors, Ramnani at Francis Financial tries to help people control their emotions "It's emotional and very hard to move from point A to point B," she said. "The more acrimonious the divorce, the more money is spent on attorneys and the more the pot is diminished. We try to help people understand that from the get-go."
— By Andrew Osterland, special to CNBC.com
