Despite recent downward trends, the facts are stark: More than 689,000 people divorced in 2021. These high numbers reveal a fundamental truth: Every year, hundreds of thousands of Americans discover just how complicated divorce finances can be. As a result, there are multiple questions to answer. What happens to your bank accounts? Your retirement accounts? Your credit card? How will a divorce settlement impact your credit score? How can you best prepare for a divorce?
These are not minor questions because a poorly managed divorce can expose you to serious financial risk. Thankfully, a divorce financial planner (Financial Advisor, Planner, or Wealth Manager who specializes in clients navigating a divorce) can ensure you properly manage thorny issues and give you access to the financial help you need.
How Divorce Affects Finances
The hard truth is that divorce can impact finances in many ways. The specific impacts depend on state law. However, divorce can impact the division of community property, pensions, overall assets, and your financial decisions going forward. On an individual level, you may need to provide spousal support payments to your ex. Doing so can have a major impact on your finances. You may need to liquidate assets, divide up checking accounts, and alter health and life insurance policies.
Divorce finances are not easy, even in the best of circumstances. As such, you'll need professional advice to make the best decisions for your long-term success.
How to Protect Finances Before a Divorce
If you know your marriage is coming to an end, there are a few basic things you can do before the start of the divorce process:
- Get a copy of all important paperwork, including a copy of your credit report, credit card statements, life insurance policies, joint accounts, and more. Doing so ensures that your attorneys are properly prepared to act on your behalf.
- Speak with legal counsel to ensure your actions comply with state law. Any qualified divorce lawyer will understand divorce finances.
- Speak with a financial planner or CPA to understand your divorce's specific tax implications.
You may complete certain financial objectives before a court order is issued, depending on your situation. However, you should be extremely careful and not make any major changes to your financial situation—including health care or life insurance—until you get the go-ahead from your attorney.
How to Separate Finances Before Divorce
Separating finances before divorce proceedings begin can be complicated, and you don't want to do anything that your partner or the court could interpret as attempting to hide money. However, there are some basic actions you can take. These include:
- Get a free credit report to ensure you know what accounts are open.
- Get copies of your tax returns. Doing so will allow you to better understand your future tax situation.
- Freeze joint accounts, stopping any further deposits or withdrawals.
- Open an account in your name.
- Keep paying joint bills. Doing so will ensure the divorce does not damage your credit.
Finally, keep in mind that experts are available to assist you. If you are considering divorce, a divorce financial planner can provide insightful and invaluable advice across various areas, including how state laws may impact your settlement, how to manage complex issues like childcare, and filing taxes after divorce.
Considerations for Dividing Assets in a Divorce
Dividing assets can be the most complicated part of divorce finances. Thankfully, when done right, you can amicably split formerly joint assets.
Getting the division of assets in divorce right comes down to paying adequate attention to multiple considerations.
Prioritize Liquidity over Sentiment
While your home is likely one of your largest valued assets, it is not necessarily the best asset to get in a divorce. All the sentimental ties to your real estate can make it feel invaluable, but it has a market value and likely comes with a mortgage—and possibly a home equity line of credit. But, most importantly, it is not liquid.
A liquid asset is an asset you can easily, quickly, and cost-effectively turn into cash. Think money market or bank accounts and liquid mutual funds or stocks with relatively small capital gains held in a taxable account, formerly joint or now under individual ownership.
Cash flow is also an important consideration as it relates to debt. Limiting the debt, you keep after your divorce will give you more cash to help you get back on your feet. In addition, if you owe child support or alimony, you need this money to manage your bills, pay your former spouse, and appropriately manage your financial situation.
Understand the Tax Consequences of Your Assets
The assets you own have different tax treatment. Some accounts, called tax-deferred accounts, allow investment income to accumulate without requiring you to pay taxes today. Instead, you pay ordinary income tax on the distributions made during retirement.
Other taxable accounts require you to pay taxes as investment income is earned or when you sell an investment with a gain. However, taxable investment accounts do not restrict when you can withdraw funds, and distributions from the account are not taxable.
A good mix of taxable and tax-deferred assets is key to financial wellness. You will likely rely on the tax-deferred accounts to fund retirement and the taxable account to fund current/short-term needs.
Because your income tax status will change, e.g., from Joint to Head of Household or Single, it's also worth consulting with a CPA or financial planner to review the necessary actions you'll need to take. This expert advice can make it easier when it comes to filing taxes after divorce.
Evaluate Your Risk
A changing marriage may mean a changing risk tolerance. As such, you should seek expert advice to determine how to structure your investments to give you the highest probability of reaching your financial goals. You can adjust risk by increasing or decreasing the amount of stock market exposure in your accounts.
You should also evaluate the cash reserve you keep now that you are a single-led household. For example, you may need to increase your cash reserve to 6-12 months of expenses to account for unexpected cash expenses.
There is one thing certain of all divorce finances: Each situation is completely different. As such, the key to your financial success is to find someone who takes a comprehensive look at your financial life post-divorce. A divorce financial planner can be critical in your long-term financial recovery.
How an Advisor Can Help with Divorce Asset Allocation
There are nearly limitless financial considerations to contemplate with post-divorce finances. A divorce-experience financial planner can help you track your assets, manage complex divisions, and assist you in filing taxes after divorce. In addition, relying on a financial planner to assist you in identifying and dividing marital assets can be an invaluable tool to help you create a financial future without your now ex-spouse. If you currently have an advisor together but are debating whether you should hire your own, you can get started on your personal path to financial independence by taking our easy 2-minute financial analysis to get personalized recommendations on where your financial plan is at risk and better assess whether Plancorp might be a good fit for you as some people find having independent advisors helpful to feel like your personal needs are being advocated for as you plan.
Looking for help before or after a divorce? At Plancorp, we're here to help, and as elite financial advisors with years of experience in helping clients manage financial assets, we can assist you in securing your financial future—even after a divorce. Contact us today to get started, minimize your financial risk, and get the financial planning services you deserve.
