Guiding your clients throughout the process
by Deanna Coyle, MBA, CFA, CLTCMs. Coyle is a financial advisor with Centinel Financial Group, LLC in Needham Heights, Massachusetts. She can be reached for questions at 781.446.5023 or by email at
As a financial planner, and having gone through a divorce myself, there are significant financial and legal issues involved when guiding individuals through a separation and divorce. At the same time, there are also non-financial issues that come with divorce, such as family and personal matters. Knowing these issues can help you properly guide your clients and allow you to bring substantial depth and value to your professional relationships.
If couples can’t solve their financial problems during the marriage, then it seems likely it will be even harder for them to agree on the financial issues during their divorce. As a result, it is becoming more common for divorce attorneys to employ the help of financial experts during the divorce process, including CPAs and financial planners. The CPA typically looks at the details of the scenario as it is today, while the financial planner looks at financial results in the future based on certain assumptions made today. These two methods can be blended for the best interest of the client.
Property and Asset Division
One of the primary areas of a divorce agreement that needs to be reached is how to divide the assets in a fair and equitable manner. People generally have three concerns regarding dividing their property: What is our property? What is its value? And how do we divide it? The types of property in question include real estate; liquid assets, such as savings accounts, CD’s, mutual funds, and stocks and bonds; and personal property, which includes vehicles, life insurance cash value, retirement assets (such as IRAs, 401(k)s, and pensions), family businesses, art, antiques, and jewelry, household goods and furniture, and other assets (such as stock options, tax refunds, gifts, inheritance, and property that was owned before marriage).
The difference between marital property and separate property needs to be determined. Separate property is what someone brings into a marriage, inherits during the marriage, or receives as a gift during the marriage. Judges’ rulings on the split of separate property can vary. Marital property is everything acquired during the marriage, no matter whose name it is in. In some states, such as Massachusetts, marital property can include the increase in value of separate property.
It is important to understand the tax consequences of transferring certain types of property, such as a house, or stock with a low basis. The division of assets during a divorce is not a taxable event. The basis goes with the property. Divorce does not create a step-up in basis, so it is upon the sale of the property that taxes are taken into account. In these cases, you need to seek the advice of a qualified tax and legal advisor.
It is also important to take into account the nature of each asset. Compare the liquidity of each asset, such as keeping the land instead of the savings account; the tax effect (such as keeping the IRA instead of the mutual fund; and the basis (keeping the house with the low basis instead of the savings account). Also take into account the appreciation of the assets and the cost of maintenance (keeping the old house instead of the new condo).
Keep in mind that equitable does not necessarily mean equal—it means what is fair. How do you decide what is fair? The courts look at a variety of factors, such as the length of the marriage, the ages of both parties and how much they can earn, their health, and the need for one spouse to become economically self-sufficient or to have funds for re-training. The division of assets can be offset by the amount of maintenance (i.e. child support and alimony) to be paid.
In looking at dividing the real estate, one needs to consider selling the house versus keeping it. If kids are still living at home, it could be desirable to keep the home so that they have less of a disruption in their lives. However, issues that need to be considered are whether or not one of the parties can afford it. Expenses such as insurance, taxes, maintenance and repairs need to be taken into account.
There are three ways that could be used to divide the house:
- Sell the house and divide the profits that remain after sales costs and the mortgage is paid off. It is important to consider the basis in the house and the tax implications of possible capital gains. Also, if your client wants to buy another residence, they will need to determine if they will qualify for a new loan.
- One spouse buys out the other spouse’s interest in the house. This can be done by trading another asset for the interest in the house. A potential problem is if the real estate market declines before the spouse sells the home, in which case your client would not receive what they had planned on in the settlement.
- One spouse keeps the house for a certain period of time, for example when the youngest child has graduated from high school, and then the house could be sold and the proceeds divided. Tax laws were passed in 1997 that have to do with selling the home at the time of the divorce and allow each spouse to take a $250,000 capital gain exclusion in their income taxes. In this scenario, 1) the spouse that moved out needs to stay on the deed as an owner until the house is sold; and 2) this intention needs to be stated in their divorce decree. The downside to this strategy is: 1) it keeps the spouses together in terms of still owning the house jointly, with both liable for principle and interest payments; and 2) the spouse who moved out is still on the deed, and perhaps the mortgage of the house, which may make it difficult for them to qualify for another loan.
With retirement assets, such as 401(k)s, pensions, and IRAs, it is important that the Qualified Domestic Relations Order (QDRO) is done correctly. For example, if a mistake is make when the QDROs are drafted, it could result in the non-employee spouse not getting the benefits that were anticipated. Other things to keep in mind are including the present value of a pension among marital assets, as well as the sometimes long timeframe that it takes for the retirement assets to be divided (i.e. when the money can move).
Financial experts need to understand how stock options may be treated as income (i.e. compensation used to calculate future support payments) or as property (i.e. division of marital assets at the time of divorce), when options may be marital versus non-marital property, and how to value the unvested stock option. Stock options are difficult to value because they’re just options. There is no set value on them right now. It is only when they’re exercised that they have value. And sometimes they’re vested and sometimes they are not. Sometimes they can be divided, and sometimes they cannot.
Career assets, such as the spouses’ accumulated vacation and sick pay; company car; health membership, company paid life, health and disability insurance are also considered in the divorce process. Other assets also include the current value of life insurance and frequent flyer miles.
With many clients deciding to divorce in their later years, it is important to have a discussion on long-term care insurance and if a provision for securing this important coverage for the non-working ex spouse should be a part of the divorce decree.
Custody Arrangements, Alimony and Social Security
The custody arrangement (increasingly referred to nowadays as the parenting plan) that is agreed upon can affect child support payments, and ultimately your clients’ current and future financial stability. Child support is not tax-deductible for the paying spouse and is tax free to the receiving spouse. You also need to help protect your clients’ ability to pay (or receive) child support with life insurance and disability income insurance. It is becoming more common for this condition to be included in the divorce agreement.
Alimony is referred to as maintenance or spousal support. It is more complicated to determine than child support as there are no set guidelines. Criteria for receiving alimony includes the need of the receiving spouse, the ability to pay of the paying spouse, the length of the marriage, previous lifestyle, and age and health of both parties. Alimony is taxable income to the person who receives it, and is tax-deductible by the person who pays it.
I often recommend that my clients gain an understanding of their spouse’s income potential by researching what their profession pays for a higher level of experience and what benefits are typically offered.
If your client was married for at least ten years before their divorce, and is currently unmarried, they may receive social security benefits based on their ex-spouse’s benefit. If they were married more than once, it does not have to be the most recent ex-spouse (as long as they were married for ten years or more). Note that claiming this benefit will not affect the amount of benefits the ex-spouse can receive (or the amount their current spouse can receive if they have remarried).
Credit Checks and Incurred Debt
Remind your clients to check their credit report to help ensure their spouse has not incurred debts in their name since the date of their separation. Legally, your clients are responsible if their ex-spouse does not pay their debts, even if they sign an agreement taking responsibility for payment. Also take into account any tax liens. If possible, file innocent spouse status by having them consult with a tax attorney or CPA.
Your client and their divorce lawyer may also want to make sure that the ex has not hidden assets. Assets may be hidden by: denying the existence of an asset; transferring it to a third party, such as a friend or a family member; claiming the asset was lost or dissipated; or the creation of false debt (i.e. a gift from a parent is now claimed to be a debt that needs to be repaid). Tracking down accounts and investments may be more difficult if the spouse is self-employed or runs their own business. Without an outside employer, there’s no easy way to check if the spouse is telling the truth about what they’re earning.
And there could be more opportunities for creative concealment of money. For instance, the value of a business prior to a divorce can be lowered artificially by delaying the signing of lucrative long-term business contracts until after a divorce settlement is reached. This is where it is important for your client to leverage a forensic accountant and also make sure that the value of any family-owned business is properly appraised.
If possible, before your client moves out of their house, have them make copies of important documents, such as their will, social security cards, insurance policies, loan and lease documents, and birth certificates.
The Role of a Financial Advisor
Financial professionals should help their clients understand the cost and future impact of maintaining two separate households. A lesson in budgeting may be appropriate here. Clients also need to keep in mind that as their children get older, they often cost more to maintain. They have more expensive hobbies (i.e. hockey, skiing, musical instruments), they eat more, their clothes are more expensive, and they might need orthodontia. The divorce agreement will help spell out the split of child-related expenses, such as tuition, extracurricular activities, and medical expenses.
Being newly single can also be a particular challenge if your client’s spouse was the head of family finances throughout their marriage. You may need to help them understand their options with money and keeping those dollars working for them to create a stable, long-term retirement. In terms of taxation, your newly single client could be paying a higher percentage of tax on their income compared to married couples.
There is the potential loss of certain tax deductions that may have been taken while married. For example, someone who received the primary residence as part of a divorce settlement would continue to take a deduction for the property taxes, while the person not receiving the home as part of the settlement would not be able to take the deduction unless they bought another home.
Challenges also include child support/alimony that could end in a certain number of years; and lower earnings ability if your client served as the primary caregiver in a “traditional” marriage. These factors would make it even more important for them to evaluate employment and savings options.
If your client is not eligible for an employer’s plan, help them set up an IRA. If they are self-employed or working at an S-Corp or an LLC, look into contributing to a SEP IRA, which can have higher contribution amounts.
It is also crucial to remind your client to update their will, healthcare proxies and financial account beneficiaries (for life insurance, 401(k), etc.), as beneficiary designations supersede whatever the will states. And remind them to have these updates and changes notarized.
Depending on your client’s employer, health insurance may or may not be continued for the non-employee after divorce. Stay at home parents and those who work part time are not covered through an employer. And they may not be able to be on their ex-spouse’s employers covered health plan. Health insurance purchased on their own can be expensive, with high deductibles. You may want to have your client open a health savings account through work, if that is an option. It is a tax deduction and is not a “use it or lose it”, like a flexible spending account is.
LGBT Separations and Divorce
While gay marriage is recognized on a federal level, states have different treatment of gay marriage. Gay marriage is legal in some states, but not in others. So if a couple gets married in a state that recognizes gay marriage, such as Massachusetts, and then moves to a state that does not, such as Florida, they may have difficulties getting a divorce. States that ban same sex marriage may not grant a divorce for a marriage that they don’t recognize. Also, some states where gay marriage is legal may impose onerous requirements for divorce. In the example here, in order to get divorced in Massachusetts after having moved to Florida, one of the spouses would need to move back to Massachusetts for six months to a year in order to establish residency. Meanwhile, the couple would need to continue to file their federal income tax returns using either the married filing jointly or married filing separately status until the divorce is granted. Problems also could arise in the case of couples who do not agree on custody. If a non-biological spouse has not legally adopted the child or children, their rights as a parent may not be protected.
The Additional Coaching You Can Bring
Chances are, you may have worked with your client for many years prior to their divorce and perhaps have been the advisor for the couple for years. As such, you are one of the most trusted advisors in your clients’ lives during this difficult time. In addition to being their financial guide, remember to take the time to discuss the non-financial issues related to divorce; which include such things as, co-parenting, re-establishing a social life, divorce stress and coping strategies, the importance of staying healthy, the importance of keeping a positive attitude, and creating the life that your clients wants for themselves and their children. Your clients will need you just as much when the divorce is over and it is important to keep those emotional bonds strong all along the way.
Registered Representative/Securities and Investment Advisory Services offered through Signator Investors, Inc., Member FINRA, SIPC, a Registered Investment Adviser. 160 Gould Street, Suite 212, Needham Heights, MA 02494. 784.446.5006. Centinel Financial Group, LLC is independent of Signator Investors, Inc. and any affiliated companies. Signator Investors, Inc. and its representatives do not provide tax or legal advice. Please consult with your own advisors for such guidance.