9 Divorce Mistakes
Though written for the financial planning community, this is a valuable article for those going through a divorce or who are counseling someone who is. --Gary
By Stephen Johnson
Attorney at Law
Conventional wisdom holds that money is the primary cause of divorce among married couples. There is growing evidence, however, that suggests otherwise. According to a recent study done by Jan Anderson, associate professor at California State University at Sacramento, money typically ranks only fourth or fifth in terms of the causes of divorce, and accounts for only 5% of divorces.
On the other hand, there is little doubt that money often becomes a tremendous problem during and after a divorce. For starters, the income formerly shared by the couple must now be used to pay for two households.
Effective financial advice can play a crucial role following a divorce. Here are some of the most frequent financial mistakes made in divorce cases, and how you can help your clients avoid them:
1. Waiting to begin establishing a separate financial life until after the divorce is filed. The process of beginning a separate financial life should begin even before divorce proceedings have been initiated. Waiting until after the divorce has begun can leave a spouse financially vulnerable. Clients on the verge of filing for divorce should be advised to take the following steps:
Open a new checking account, solely in their name.
Apply for and obtain a credit card in their name.
Close any joint credit card accounts and lines of credit as soon as possible.
2. Failing to develop a financial plan for the initial phase of the divorce. One of the first issues that parties grapple with upon filing for divorce is how finances will be handled until the time that the divorce is finalized. Immediate decisions must be made about who will live where, what the financial needs will be during the interim period, and how income during the period will be divided.
For good decisions to be made, the client must have an accurate picture of their new household budget and financial needs. However, in the early stages of the divorce, clients often feel as though they’re in the middle of a storm, being bombarded with a million decisions to make all at once. The result is a tendency for clients to underestimate or even omit expenses when working on their initial budget. The stakes are high, since financial mistakes made early in the divorce can have negative consequences that affect the course of the entire divorce proceeding.
Helping the client to understand their changing financial picture will give them a solid base to operate from as they work through the divorce.
3. Mis-evaluating proposed settlement agreements. Most divorces wind up settling out of court, and the settlement agreements reached in divorce cases can have a lasting impact on a client’s finances. Clients need to understand the long-term implications of any division of marital assets being proposed, so that sound decisions can be made.
You can play a vital role in helping the client to understand the long-term financial projections for any settlement agreements that are proposed, by providing information on issues like the anticipated appreciation of assets to be received under the proposed agreement, long-term costs associated with certain assets, such as maintenance expenses for a house, tax ramifications of the settlement proposal, and ultimately, in helping the client in deciding whether a particular agreement is fair from a financial point of view.
4. Ignoring the need for a new, post-divorce financial plan. Once the divorce has been finalized and the marital assets have been divided, there is often an understandable sense of fatigue on the part of the client. One of the results of this fatigue is a tendency to simply let the assets remain where they are, without engaging in any further analysis or planning.
However, the particular assets that the client winds up with from the divorce are often not an appropriate set of assets for them long-term, in light of their new financial and marital status. The level of risk may not be appropriate. There may not be sufficient diversity or liquidity with respect to the assets. After the divorce, clients should be encouraged to develop a new set of financial goals and a new financial plan.
5. Becoming house-poor. The most common example of this is a mother deciding to keep the family house, without having the financial resources to afford it. Although providing stability for the children is certainly a worthy goal, all too often, this decision is made without a clear understanding of the true costs involved. The mortgage payments are just the beginning, with the total costs also including utilities, repairs, maintenance and the like.
Even if there are sufficient financial resources to keep the house, there is often another unrecognized long-term consequence, for this reason: when one spouse receives the house in the divorce, the settlement agreement often provides that other spouse receives the retirement accounts. However, the appreciation on residential real estate typically runs 2-3% per year, whereas the return on retirement investments often averages two or three times that much. Even if the house has the same value now as the retirement accounts, the retirement accounts may be worth much more down the road -- so what looked like a 50/50 split of the assets at the time of the divorce turns out to not be an even split at all.
Help the client understand the ramifications of the housing decision, so that they have a clear understanding of the possible consequences. If appropriate, suggest that they explore alternatives to keeping the house, such as moving to a less expensive house in the same school district.
6. Making decisions based solely on emotions. Negotiations can often come to a complete stop over what appears to be relatively minor issues, such as who will receive a particular piece of furniture or other possession. Of course, the truth is that the dispute is rarely over the possession itself, but stems from psychological or emotional issues that the parties are dealing with. The irony is that the asset itself is often worth just a fraction of what the parties wind up spending in legal fees fighting over the issue.
You can provide a valuable service by being an objective voice as the client works through the divorce, and discussing with the client the financial consequences of the issues being considered.
7. Bypassing the benefits of insurance. Life insurance and disability insurance are just as important following a divorce as they are prior to divorce.
In particular, clients who are to receive child support or alimony (which in Texas is called "maintenance") should obtain a life insurance policy on the life of the other spouse, so that if that spouse dies, the client will not be left without the financial support that otherwise would have been provided. For the same reasons, clients should also be advised to obtain a disability policy.
Additionally, the spouse who is to be the recipient of the child support or maintenance should be designated not just as the beneficiary of the policy, but also as the owner, so that the policy cannot be changed without their knowledge.
8. Relying on resource materials that don’t apply to divorces in Texas. Divorce laws vary tremendously from state to state. For example, Texas is in the minority of states that take a community property approach to marital assets. Make sure that the client is aware that divorce-related materials obtained from the Internet, or from books or magazines may not apply to a divorce in Texas, so that the client’s understanding of his or her rights is not based on bad information.
9. Forgetting to revise beneficiary designations and estate planning documents. It is usually necessary, following a divorce, to remove the ex-spouse’s name from beneficiary designations on instruments such as IRAs and 401(k) accounts, and to revise estate planning documents. At the same time, these are details that can easily fall through the cracks and be forgotten. Follow up with clients to make sure that they have made any necessary changes.
In the same way, if a Qualified Domestic Relations Order, or "QDRO" (the order used by courts to formally divide certain types of retirement plans) has been entered by the court, make sure that the client follows through with submitting it to any retirement plans affected by it. This is particularly important if the retirement plans are held in the name of the client’s ex-spouse. If the client’s ex-spouse dies, quits or is fired, or withdraws money from retirement accounts before the QDRO is submitted to the retirement plan administrator, the client’s rights to the funds could become forfeited or impaired.
When going through a divorce, clients are usually venturing into uncharted territory. By providing timely and objective advice, you can help to ensure that they emerge from it headed in a sound financial direction.
Stephen Johnson has practiced law in the Dallas/Ft. Worth area for 13 years. His article, "11 Critical Steps To Take Before Filing For Divorce," is provided free upon request by calling his office at (972) 678-2566.
© Copyright 2004 by Stephen Johnson. All rights reserved.