Financial Planning for Clients in Transition

How do you best advise someone in times of divorce, loss of spouse or career change?

by Erica Mellone, CFP, CLTC

Change can be exciting. However, change can also be difficult and emotionally draining. Most life events will have an effect on one’s financial situation, sometimes without the client noticing or fully understanding the changes.

Therefore, it is important for any change or transition to be reviewed through a financial planning lens that examines opportunities and potential mistakes that may affect one’s income streams, taxation, and overall financial wellbeing. Statistically, women live longer than men, which can pose challenges during transitions such as divorce, the passing of a spouse, or a career change. Within the major financial topics pre-retirees have on their minds, there are many considerations worth reviewing with a professional before finalizing any decisions involving life changes or transitions.

Taxation During a Divorce

During the process of a divorce, there are many very important topics at hand that legal teams are often involved in – custody of children, splitting of assets and possessions, financial support, as well as emotional strain. While focusing on the task of separating, couples often lose sight of tax advantages that may help them leave their marriage with more in financial resources for each spouse.

One simple way to potentially reduce taxes for one final year is to examine the benefits of filing as married versus married filing separately, depending on your situation. While you may be separated, if you are still legally married, preparing a joint return may be beneficial as married couples can find themselves in lower tax brackets than their respective tax brackets when filing single. Less money spent on taxes translates to more funds in the marital estate. Occasionally the reverse is beneficial – being able to file as a single individual – and couples looking at a smooth divorce could consider a faster pace to finish the divorce by the end of the year.

If it is likely that the primary residence will be sold to satisfy the divorce agreements or as part of the separation process, couples who have owned their home for long enough to experience significant gain may prefer to sell their home while being able to shelter a larger amount of the gain from taxation. Again, a lower tax bill means more funds in the marital estate. As a single individual in 2017, one has a $250,000 exemption of gain in a primary residence, however a married couple has a $500,000 exemption. Depending on the divorce timeline and the housing market, selling the primary residence while still married can be financially advantageous.

Considerations when using a QDRO

A Qualified Domestic Relations Order (QDRO) is often used when spouses have retirement accounts that need to be utilized to satisfy a separation agreement. A QDRO is an order for a retirement plan to pay child support, alimony, or marital property rights to a spouse, child or other dependent. The benefit of a QDRO is that spouses are able to transfer funds to each other without taxation or early withdrawal penalties, therefore preserving the tax advantages that come with these retirement accounts. While a QDRO is necessary for this type of rollover, it’s important to review the accounts the funds are currently in and confirm if there is a more optimal (or less optimal) time to transact the rollover, and in some situations, determine if the QDRO would be accepted.

Generally, there is no time limit on the rollover, although many individuals want to move through the process quickly, and advisors would be concerned with the funds being managed to reflect the receiving spouse’s risk tolerance. A QDRO will often use terminology to reflect a portion of the account value as of a specific date, and the rollover would be calculated pro rata based on the investment experience of the account.

In instances where one spouse is to receive part of a pension fund, it may be advantageous to leave all or some of the receiving spouse’s share in the earning spouse’s pension. Pensions receive creditor protection that is often not available in the IRAs that pension funds would be rolled into. The pension itself may also be more flexible with loans and pre-age 59 ½ distributions than an IRA. Additionally, many pensions have a life insurance benefit that can be retained. While a rollover has its benefits – allowing you to have the investment allocated and invested appropriately and for beneficiaries to be correct – it may not be something to rush into. Before completing the QDRO, confirm that a pension can give an immediate lump sum, and if not, consider other methods of splitting assets.

While in the process of the separation, individuals should consider having a professional review the summary plan description. In some instances, especially with employer stock options and private equity, a QDRO would not be accepted. While the divorce agreement may state that a spouse is entitled to a certain amount of assets, if the account is not as liquid as assumed, there may be significant delays in receiving the funds and the need for additional litigation which would be costly – both financially and emotionally.

For example, consider that you are awarded half of your spouse’s retirement plan and stock option value, and have a QDRO written to reflect that. Sending the QDRO to the plan administrator does not necessarily mean it will be honored. The plan could specifically say that the shares cannot be transferred. If the nonemployee spouse was planning to use these funds to cover legal fees or current expenses, that would be devastating news that could have been prevented. In addition, other assets could already be in the process of being split, potentially making the adjustments more difficult. Taking the time to proactively review all the details could save you time, money and headaches.

Maximizing Social Security Benefits for Survivors and Divorcees

While recent changes to Social Security put an end to a financial planning strategy that married couples have used in the past, there are still planning opportunities and considerations for widows and ex-spouses. With the loss of a spouse, often the woman is affected more by the change in Social Security. While a survivor is entitled to a maximum of 100% of deceased worker’s benefit, an ex-spouse may only receive up to 50% of the worker’s full retirement age (FRA) benefit. The difference in benefits is larger than what may be apparent – a survivor is entitled to any delayed benefits that may have accrued, while an ex-spouse is not. It is important to keep in mind that filing early reduces benefits, however, survivors are able to file as early as age 60 without a penalty.

Divorcees should also be aware of important timelines regarding Social Security benefits. In order to collect benefits, the marriage must have been for longer than a year if filing for spousal benefits (and 9 months for survivor benefits). Many divorcees remarry, and therefore should consider the implications. At the time of remarriage, the social security benefits based on the previous spouse’s full retirement age will stop; however, if a widow over the age of 60 remarries, their benefits will continue. Someone over the age of 60 who was widowed and remarried could choose between three social security income options – their own, their survivor benefit, or their spousal benefit.

It’s important to remember that filing early for a spousal or survivor benefit does not affect one’s own benefit. An individual could effectively claim survivor benefits while deferring their own benefits past full retirement age and filing for their own benefits when the payment was larger.

Social Security remains to be more complicated than it may seem, and a benefit review can help determine whether there is more income that could be made available with the right planning.

Career changes – when women stop working or pursue new opportunities

Women have more choices and opportunities in the workplace than ever before. Some women choose to stay with their company for many years and move up the corporate ladder, while other women seek new positions outside their current employment, perhaps at a startup where a large part of their compensation is through an incentive package. Women may also stop working to spend time with children, care for their parents, or to pursue a passion project that is not focused on the income. In all instances, both spouses’ life insurance policies should be reviewed, both from the perspective of providing for dependents and making sure that she is provided for.

When changing jobs it is important to review your new benefits package. If employer-provided life insurance is reduced, or if you are earning more, you may need to increase the amount of life insurance you own yourself. Additionally, if a woman takes herself out of the workforce, it’s important to make sure there is enough insurance on her spouse to ensure that she will be able to maintain the lifestyle she wants. If a woman is caring for other family members, they may need her support even more after the passing of her spouse, and it would be the least opportune time to resume working. Financial planners and insurance professionals can help you review your cash flow and design an insurance plan that meets your specific needs and goals, whether that is paying for a mortgage or college education, or generating an income stream.

The Importance of a Beneficiary Audit

Often when a married couple addresses their finances, the account owner’s spouse is listed as the primary beneficiary on investment accounts. This serves for both a smooth transition in the event of death and allows for the unlimited marital deduction the surviving spouse is entitled to.

During a divorce, it’s possible that not all assets will be split and employer sponsored retirement accounts may remain open with future contributions planned. Additionally, life insurance policies may be taken out to insure the income of a spouse paying alimony or child support, and that income stream requirement may cease before the insurance policy expires. Beneficiary designations are considered contractual, and it is very rare to see them contested in court. Life insurance policies do not go through probate, meaning that a will won’t protect your new beneficiaries if you have not formally updated them.

A financial planner should address this with clients. However, if an individual is not working with a professional then it is extremely important to examine all of their accounts and request the appropriate forms in order to change their beneficiaries. Clients should contact their estate planning attorney to review beneficiaries of trusts and to examine other areas that are often overlooked – reviewing who has the power to make healthcare decisions, and determining if a power of attorney needs to be revoked.

Whether you are in a long and complicated transition, or if it just feels as though you are, it’s important to know that you don’t have to go through it on your own. There are experienced professionals that can assist you with your goals and add valuable insight into options and issues that you may not be aware of. You also don’t need to limit your team to just one or two professionals. Attorneys, CPAs and Financial Planners can all work together in their client’s best interest to help you take strong steps forward into the next chapter of your life. ◊