Even well-constructed income plans can unravel in a heartbeat
by Lili VasileffLili A. Vasileff is President of Wealth Protection Management, based in Greenwich, CT, a mediator, Certified Divorce Financial Analyst, and litigation divorce financial expert. She is a nationally recognized speaker, practitioner, writer, and author of four books on divorce, including: “Money & Divorce: The Essential Roadmap to Mastering Financial Decisions” published by the American Bar Association. Lili is the co-president of the national Association of Divorce Financial Planners (ADFP). Her awards include the prestigious 2013 Pioneering Award for outstanding public advocacy and leadership in the field of divorce financial planning. Her website is www.wealthprotectionmanagement.com.
Getting divorced later in life is an increasingly common phenomenon, but it comes with added challenges. Loved ones are often shocked when a couple divorces later in life. The individuals involved are usually more concerned about how they will catch up with retirement savings and become independent after many years of marriage. Plans they may have made, or the retirement they envisioned for their future together, quickly fall away to reveal a harsher, more stark reality. Income may no longer be sufficient to support two households; marital assets are typically halved in long term marriages.
What’s left is a legal process that exposes gaps in financial planning, faulty assumptions, compromised efforts, and often, conflicting goals between spouses. Yet, divorce commands a couple to commit to financial decisions that have a long-term impact.
More than 55% of gray divorces (defined as age 50 plus) occur with couples in first time marriages of duration over 20 years. Primary concerns are:
- Worry about if income will be sufficient if divided between two households
- Concern about spending on health care & probable need to downsize
- Anxiety about what happens when spouse retire and no longer earn income – outliving one’s assets
- Apprehension about achieving financial independence
A Shorter Earning Horizon
What makes late life divorce different is that individuals have a shorter time horizon to replenish savings before full retirement age. It is also more difficult to generate higher earnings in a career late in life when one presumably is already at their peak earning years. Conversely, the pandemic has caused many individuals to take voluntary early retirement or be laid off involuntarily from the work force. It is difficult at best to get back into the work force if having been sidelined or a homemaker for many years.
The challenges of restarting, reinventing, or creating new earning capacity are not to be underestimated. At this stage in life, Boomers face many hurdles: demanding jobs, college tuition, adult boomerang children, blended families, skyrocketing health care costs, financial responsibility of caregiving for elderly parents, and family-owned business (economically hurting from the pandemic). Psychological and emotional depression is common in divorce.
Divorce presents a complex set of issues relating to retirement preparedness. The timing of divorce seems to matter, as does the division of assets following a divorce.
Divorce reveals in the present tense what will become evident over time in the future. The burden of preparing for retirement is increasing as we all face more risk and rising costs.
Neither Savings Nor Pensions
Study after study report depressing facts: nearly 29% of households age 55 and older have neither retirement savings nor a pension; of those who save, one in five have no idea how much their partner is saving; nearly half disagree on when they will retire and on the lifestyle they expect to live.
Divorced people are far less prepared for retirement than their married counterparts. According to the Federal Reserve, divorced people believe they are 75% short, on average, of their retirement needs, while married believe they are 34% short. This perception is borne out by the fact that retirement accounts are 7 plus times bigger for married couples than divorced.
Older women are particularly vulnerable and rank money issues as the number one concern in divorce, topping concerns for their children. Post-divorce decline in income hits women hard. According to National Institute on Retirement Security (NIR), women are 80 per cent more likely than men to be impoverished at age 65 and older, due in part to unequal pay parity and employment levels. Women who are widowed, divorced and over age 70 rely on Social Security benefits for the majority of their income.
Divorce is a powerful pivot for transitioning into retirement. You obviously want to get what’s rightfully yours and take steps to protect your financial security. Here are four important financial areas you’ll want to address before you are divorced:
- How will you maximize income from all sources
- When to coordinate and plan Social Security claiming strategies if receiving alimony and/or working
- Why you must negotiate for “key” assets, such as “golden” pensions and annuities
- Which assets can be squeezed to produce cash flow without penalty or taxes
Alimony’s Persistent Need
State laws govern the amount and duration of alimony in long-term marriages. Several factors, and sometimes formulas, help to determine a just and equitable amount. Spousal support is a financial obligation defined in the divorce judgment. Although the payor’s income may go down or end when he/she retires, that doesn’t mean that alimony will terminate or be reduced (absent terms being clearly defined in the judgment). Rather, it most likely will be necessary for the payor to file with the court to obtain a modification order. The outcome is unpredictable and uncertain for both ex-spouses. Some states have new statutory laws that terminate spousal support at payor’s normal retirement age, even if the individual continues to earn income.
For the recipient of alimony, there are often downside risks for increasing income while collecting alimony. Nevertheless, many individuals have to increase income or seek employment not only to plug budget deficits, but also to acquire health insurance (before Medicare eligibility and upon expiry of COBRA coverage). If necessary, you should preserve your right to meet your reasonable needs with a safe harbor clause. A safe harbor clause allows the lower income spouse to earn up to a certain amount without triggering a modification to reduce alimony.
Social Security: Claim Now… Claim More Later
You may have the option to claim Social Security based on your ex-spouse’s work record if you meet criteria and it is a bigger benefit than your own. If you happened to be born before 1953 and are not remarried, you can still take advantage of the “Claim Now, Claim More Later” strategy. This means you take your spousal benefit from your ex-spouse’s record at age 66 and wait until age 70 to take your own benefit, when it has earned four more years of delayed retirement credits.
If you are younger than full retirement age and working while collecting Social Security benefits, it is possible that total income may be high enough to have the Social Security benefits reduced dollar for dollar under the earnings test. For earnings limits, the government doesn’t count income from alimony, investment earnings, interest, pensions, annuities, and capital gains.
If you are older than full retirement age and working while collecting Social Security benefits, there’s no benefit reduction based on income. However, all sources of income always count for the purposes of determining whether income is high enough such that Social Security benefits are subject to federal, and in some states, income taxes.
Other “golden” sources of income that are helpful in later years include annuities and pensions. They provide for a guaranteed future stream of income or a lump sum payment at a certain date. Pensions are defined benefit plans that provide monthly income for life to the plan participant and guarantee that the plan participant will never outlive their retirement plan savings.
Married spouses have a right to a survivor’s benefit, with federal law stating that a surviving spouse of a deceased plan participant must receive at least half of what the participant was receiving each month. The exception being if the spouse waives their right to receive lifetime payments. In divorce, the assigned monthly benefit will be recalculated over the actuarial life expectancy of the non-employee spouse. The survivor benefit is not an entitlement but may be negotiated: if the plan participant predeceases retirement payout or if either ex-spouse dies while receiving distributions.
Not to be overlooked are hidden treasures, such as cash equivalents, that can have a real positive impact on cash flow. Cash equivalents include mileage points, reward points, rebates, refunds, timeshare points, HSAs, tax loss carry-forwards, etc. Many items give you extra value for purchases that are already made and can be earned toward virtually anything.
There is often no cost to enroll in a program that offers additional incentives. Tax loss carry-forwards are valuable assets. A tax loss carry-forward is a “negative profit” for tax purposes. They allow you to use a tax loss from a prior period to reduce or offset a future profit. Individuals can generally carry forward a tax loss indefinitely and use them for many purposes: to offset capital gains from selling investments, a house, a business, or ordinary income up to $3,000 per year.
Divorce further provides unique opportunities to squeeze certain assets to withdraw cash without incurring penalty or taxes. These opportunities include (a) taking out a loan; and (b) making a permanent withdrawal.
One could borrow against the cash value in a permanent life insurance policy. Cash value is the accumulation of funds that remains after your premiums pay for policy fees and expenses. The available loan will be a percentage of the cash value and depends on the rule of the insurance company that holds the policy. Interest is charged but you do not pay taxes and you do not need to pay them back. However, not repaying the loan will result in a reduced death benefit for heirs.
Another strategy for home equity solutions involves a modern reverse mortgage. Now available through qualified lenders approved by HUD, divorcing spouses may be eligible for this kind of loan depending on home value, prevailing interest rates and their age. Taking out equity from a home and turning it into positive cash flow, a lump sum payment or even a line of credit, may help achieve housing parity between divorcing spouses as well as provide liquidity.
Depleting retirement accounts should always be your last resort. But if you must tap into your qualified retirement plan(s): (a) to take early withdrawals or (b) to take out a loan.
Dividing Qualified Plans
When dividing a qualified retirement plan such as a 401K or 403B, the non-employee spouse can elect under IRS rule 72t (c), to take cash out in a Qualified Domestic Relations Order (QDRO) without incurring an early withdrawal penalty of 10% (but will pay income taxes). Cash can be used for any purpose, such as paying bills, paying off debts, creating an emergency fund, making a down payment on purchase of a home, etc.
Taking out a loan from a qualified retirement account allows access to the money in the plan without taking a permanent distribution, thus avoiding taxes and early withdrawal penalties. Loans taken from qualified plans are subject to limits and specific repayment terms. One can borrow up to 50% of the vested account balance or a maximum of $50,000, whichever is less. One advantage of taking a loan is that the interest you repay on a qualified plan loan is repaid to your own plan account (yourself). Certain types of defined benefit plans (pensions) may also allow for loans if certain requirements are met, but you may have to get your spouse’s consent if still married.
Divorcing later in life makes a difference in retirement preparedness. Divorce financial professionals provide clarity on many topics, claim authority to guide, and offer a better education for more effective results. Wisdom cuts two ways: keeping divorcing individuals from developing false ideas and expectations during divorce; and, keeping them from making ignorant decisions in retirement. A divorce financial expert will develop and explore all options to solve for long-term financial security.