10 Financial Mistakes to Avoid When Getting a Divorce
After 16 years in the divorce industry, I've seen firsthand how mistakes in the divorce process can lead to a bad outcome. I don't want that for you. That's why I'm sharing exactly what to do to avoid making a move that could impact your economic well-being. Some of these you may have heard before (although it's good to be reminded), but lots are even more important in light of the recent pandemic.
Mistake 1: Ignoring your credit
If all your credit is tied to your spouse, consider opening an account or credit card in your own name. Why? So you can establish a credit history. If you have an account (like a car loan) with your name on it (or shared jointly with your spouse), try to agree on how these bills will be paid. Missing payments can quickly deteriorate your credit score. You don't want that – especially if you hope to refinance your home or qualify for a rental space.
On the topic of credit, it's a good idea to pull your free credit report. Look for accounts you may have forgotten about as well as anything suspicious. If you can, exchange credit reports with your spouse as well.
Mistake 2: Harping on the past instead of focusing on the solution
The quickest way to run up legal fees is by living in the past, trying to teach your ex a lesson, or using the system to "punish" them for something.
But the system is not punitive. It rarely actually "fines" spouses for bad behavior. (Sorry.) Unless you can prove fraud (which is a very high standard), it's tricky to "get back at your spouse" for not playing fair. Divorce is not a zero-sum game. You both can have a few "wins" while finding a solution to meet your needs. If litigation is necessary, perform a cost-benefit analysis before you head to court.
Mistake 3: Dividing retirement benefits improperly
Most people think a divorce agreement is enough to divide a pension or 401k. NOT SO.
Usually, an additional order called a Qualified Domestic Relations Order (QDRO), is necessary. You need a QDRO to avoid tax penalties associated with an early withdrawal (before retirement age) of benefits.
Mistake 4: Relying (only) on lawyers or opinions to value complex assets
Do you have an ownership interest in a business or unvested stock? Maybe you have a separate property interest in a house. Does your spouse hold intellectual property, like a patent? This property should be properly valued for three reasons:
- You don't want to "cheat" yourself by agreeing to a value far lower than fair market value.
- Your opinion (no matter how reasoned it is) or a lawyer's educated guess isn't persuasive in negotiations. This is especially true if trust is at issue between spouses.
- If you have to litigate, a forensic accountant or another professional can help you establish your position before a judge. In some cases, it's required.
Quick tip: It's easier and cheaper to hire a joint neutral expert to help value difficult or complex assets.
Mistake 5: Ignoring tax implications
The IRS treats most transfers between divorcing spouses as "incident to divorce" (and therefore non-taxable). However, there are plenty of instances where tax ramifications are present. These issues could cause you to lose money or miss out on important benefits.
In a divorce, when you divide one household into two, every penny counts. Before signing that final judgment, consult a CPA.
These are the mistakes I see most often:
- Not realizing your tax status is determined by your marital status on the last day of the tax year
- Not realizing you can qualify as head of household even if you're still married
- Allowing your spouse to pay off their share of an asset over a lengthy time (like a decade or more)
Mistake 6: Not paying attention to the market
We are seeing major financial uncertainty in the economy. Depending on how risk-averse you are, the volatility of the market should be taken into account when you negotiate your divorce agreement. If you agree to transfer some of your 401k to your spouse, consider using a percentage instead of an amount. That way, if the value drops, you aren't stuck giving your spouse a windfall.
Another example involves your family home. If you believe your home will drop in value, now might be a good time to sell. Or, perhaps you wait to address the buyout amount until you have a better idea of what the fair market value is.
Mistake 7: Not getting legal advice when you need it
Child support and spousal support can get pretty complicated. This is especially true if you have a long-term marriage or a child with special needs. A legal coach can help you understand where you have leverage, what your best-case scenario is, and what a fair result would look like.
Income can get tricky, too. Not everyone has a W2 job. Example: Sometimes, your business pays for personal expenses. In some circumstances, the funds used to pay personal expenses could be considered "income" for purposes of calculating alimony or child support.
Mistake 8: Ignoring the cost of divorce
Not everyone can afford a lawyer on retainer. Heck, even people who can afford it may not want to fork over thousands of dollars. Research your options. Remember, most divorces don't happen overnight. You have time, so don't rush to choose until you feel confident about your decision.
Mistake 9: Letting emotion take over
Easier said than done, I know. I see this most often in two contexts:
- Making a bad deal because you are too attached to the sentimental value of assets
- Over-using your divorce lawyer to fight about stuff that really won't matter in a year or two
You must treat your divorce negotiation like a business deal because, frankly, IT IS. Even an amicable divorce is grueling. It's unreasonable to think there won't be conflict or emotion. That's normal. But what you have to do is NOTICE. Being hyper-aware of where and when you are emotionally triggered can help you and your team plan a strategy. The goal is to agree without giving away the farm. Sometimes, it's as simple as negotiating in writing so you have time to process all settlement offers.
Mistake 10: Forgetting to update estate planning documents
After divorce, to the extent you can under your decree, change the beneficiaries on your pay-on-death accounts and life insurance policies. Update your will and trust so if you pass away, the people you want to inherit from you are protected. Consider drafting a power of attorney so if you become temporarily or permanently incapacitated, you have a trusted person who can act on your behalf.