Gray Divorce: Financial Considerations
Gray divorce is defined as divorce later in life, after age 50. Older couples in long-term marriages are divorcing at greater rates than any other age group. The divorce rate for those over the age of 50 has doubled since the 1990s. For those of over the age of 65, it has tripled.
There are many reasons for this proliferation of divorce in older couples. Longevity is a key factor, with people living longer and not wanting to spend an additional 20, 30 or even 40 years in an unhappy union. Spouses with children often wait until the nest is empty or almost empty. Of course, there are a myriad of other reasons.
Divorce later in life brings with it a host of consequences impacting a critical financial juncture in your life. It is important to understand what is at stake regarding your finances at this time in your life until the typical retirement age during your late fifties and sixties.
Often, when couples are finalizing their divorce and exchanging settlement proposals for the marital settlement agreement (MSA), the focus is on the immediate items and valuation of those assets at that specific point in time: division of the marital home, personal property, real estate and savings/investment accounts.
Although spousal support may be a factor in some gray divorce situations, oftentimes, the wage earner(s) is retired, near retirement or a spouse is over 59.5 years of age and able to access the retirement accounts penalty free, making spousal support infrequent or of limited duration.
It is especially important during divorce, to make settlement offers with a long-term outlook. That is, it is critical to take into consideration the components of what factors affect retirement income and planning for retirement benefits. Equally salient is structuring a settlement to capitalize on financial security during retirement that may last several decades given current longevity projections.
Property Division
All assets are not created equal. Retirement assets are tax-deferred but taxed at ordinary tax rates, at both federal and state (where applicable) levels upon distribution. The required distribution age starts at 72 and the amount is predetermined by your age each year by the federal government.
While it may seem desirable to negotiate for assets that grow tax-deferred, the taxes owed upon withdrawal may be much more than the 15% or 20% long-term capital gains taxes due on non-retirement accounts. Keen attention to the tax component of assets is crucial.
If assets are held longer than 12 months, they are taxed at a favorable capital gains rate. These rates are contingent upon your modified adjustable gross income and may be lower than the ordinary income tax rate that you may be subject to at the time of withdrawing the required minimum distribution. Taxable income during retirement may come from a variety of sources including social security income, pension income and other passive income received.
Takeaway for your MSA
Calculate the tax impact of the assets you are considering dividing with special attention given to the probable net amount to be received at a future date. Tax consideration of each asset goes beyond just dividing assets based on a snapshot of the investment at the time of divorce based simply on the net worth statement or marital balance sheet.
Remember that there is no step-up in basis for assets at the time of divorce. The IRS requires that the basis associated with the asset carries over to the owner of the asset. This applies to transfer of assets pursuant to a divorce degree and not more than six years after the divorce.
Required Minimum Distribution
One key milestone is the window between your retirement date and the required minimum distribution (RMD). The government has extended the minimum age when it requires a minimum distribution from your pre-tax retirement IRA, SEP, and 401(k), 403(b), etc. to72 years old.
At the time of withdrawing the required minimum distribution, you will be taxed on the withdrawals. Rather than incur a larger tax bill as the assets grow tax-deferred, it might be wise to convert these traditional accounts to Roth IRAs.
This will require payment of income tax at the time of these conversions, but afterwards, the money will grow tax-free.
The benefit of Roth Conversions is flexibility. After paying the taxes, you are able to draw income from the IRA tax-free regardless of the appreciation realized. It’s important to note that there is a five year waiting period after conversion before you may withdraw those assets, or you will forfeit the tax-free appreciation, so plan accordingly.
When deciding whether to offset retirement accounts with after-tax accounts, realize that there may be another option with Roth Conversions, even though taxes will need to be paid.
In addition to the tax-free appreciation, you will benefit from no requirement to take RMDs, affording greater flexibility in your retirement income planning needs.
Takeaway for your MSA:
To receive the greatest benefit of this conversion, use assets outside of the retirement accounts to pay the tax on conversion and keep the retirement assets intact. This affords the highest tax-free appreciation and tax-free withdrawal. This may require negotiating for enough liquid assets to pay the taxes owed for conversion.
The timing of the Roth Conversion should be during your low income producing years. If you are receiving spousal support, it is not taxable for federal income taxes. It might be a prime time to convert your pre-tax retirement to a Roth IRA since your marginal tax rate may be at a lower level.
Social Security
Although you can begin receiving Social Security as early as age 62, your monthly benefits may be reduced up to 30% for life. Conversely, each month that you delay collecting your OWN earned Social Security benefits, beyond your full retirement age, up to age 70, increases your eligible benefits.
In order to receive your ex-spouse’s benefit, the following requirements must be met: 1) married a minimum of 10 years, 2) currently single, 3) ex-spouse must be age 62 or older but does not have to file for benefits for you to receive benefits 4) you must be at least age 62 5) the benefit that you would have received on your work history is less than the benefit (50%) you would receive based on your ex-spouse’s record
You receive your full social security amount at your full retirement age, which is 66 for most people claiming at this time. Check the Social Security website to determine your full retirement age which is determined by your birth year.
Waiting to receive benefits until age 70 based on your OWN (not your ex-spouse’s) work history will increase your monthly benefit by up to 8%. If you are able to bridge the gap and defer claiming Social Security based on your work history, you may realize a significantly higher monthly benefit for the duration of your lifetime.
Takeaway for your MSA:
A spouse may collect the larger of his/her own Social Security benefit or one-half of their ex-spouse’s benefit without affecting the other spouse’s benefit.
If you want to claim at age 62, your benefit could be reduced up to 30% regardless if it is claimed on your work history or your ex-spouse’s. Waiting until full retirement age is preferable in most situations.
When structuring the MSA, consider assets that might help bridge the gap between taking Social Security early (62) versus at full retirement age or even at age 70 (your own work history). This will enable you to defer Social Security and collect a larger benefit, either yours or one-half of your ex-spouse’s.
Structure the MSA for you to be awarded assets that produce passive dividends, interest, rental income, etc. that supplement any other earnings during this period before full retirement. Alternatively, plan on earning wages that will help close the gap in the meantime, but be cognizant that a spousal support obligation may be a factor.
Medicare Premiums
Medicare premiums are based on your modified adjusted gross income on your tax return from two years prior. Tax return information from the year you turned 63 will be used to determine your premium for Medicare at age 65.
Medicare premiums are higher for higher levels of income, commonly referred to as the Medicare surcharge. If your modified adjusted gross income is greater than the maximum allowed for the standard premium, your monthly premium will be adjusted higher.
It is important not to have any triggering events that would cause an extraordinary increase in your realized income at age 63 or later. This may be the deferred sale of rental property or the marital home which has appreciated.
For every year after age 65, Medicare will look back two years to determine the premium for that year. It is important to also consider the timing of Roth conversions, discussed above, and the cost/benefit of conversion with Medicare premium
Takeaway for your MSA
Agree on division of any assets, deferred sales, etc., before you turn age 63 whenever possible to avoid the penalty of the Medicare surcharge.
Minimize the realization of any extraordinary income during the years which will affect the Medicare premium.
Health Insurance Before Age 65
You are responsible for your own cost of health insurance from the time of the divorce until age 65 when eligible for Medicare if you are not employed and receiving healthcare coverage from your employer.
There are unique Consolidated Omnibus Budget Reconciliation Act (COBRA) provisions that apply to divorce. A spouse is eligible for COBRA coverage for up to thirty-six months after divorce as opposed to eighteen months provided at the termination of employment.
Alternatively, there may be less expensive coverage through the federal Health Insurance Marketplace. Each state manages its own marketplace of insurers and a variety of plans.
If you are self-employed, you may be able to deduct the cost on your taxes. Check with your CPA for structuring your business entity to enable the deduction.
Takeaway for your MSA
If possible, in the division of assets, ensure that there is some offset to you to help subsidize the cost of healthcare if your ex-spouse will still have his/her healthcare covered through an employer.
This applies whether you select the COBRA, marketplace or off-marketplace plan.
Consider in your financial negotiations that annually, healthcare costs increase approximately 8%.
Long-term Care Insurance
Most people think that Medicare will cover their long-term care needs should they require an assisted living placement or skilled nursing care setting in the future. At this time, approximately 60 percent of adults will require about three years of care in such facilities in their lifetime.
When individuals can no longer perform the Activities of Daily Living (ADLs), there may be a need for assistance either at a facility or in-home care. Most adults would prefer to age in place in their own home, but this alternative is even more costly if not provided by a family member at no charge.
Many are surprised to discover that Medicare does not cover this cost. It is up to individuals to use their assets and self-insure, reallocate assets to be eligible for Medicaid or purchase long-term care insurance.
Long-term care planning is especially critical for divorcing couples in their later years. The probability of need increases and for single individuals, there is not always another caregiver to provide the support needed.
In 2022-2023, long-term care in an assisted living facility (non-nursing care) costs approximately, $5,000-10,000 per month, depending upon your geographic location. While the number of years an individual might need this level of care averages only 3-4 years, it is still a significant cost that can deplete retirement savings.
Takeaway for your MSA
It is important to have the funds to purchase long-term care insurance or to consider the availability of assets, either retirement funds or non-retirement funds, to support the cost of the average long-term care stay.
Having greater liquid assets than illiquid assets, such as real estate or private equity investments, may be preferable in case the need arises for long-term care costs.
In summary, there are many considerations to ponder and plan for during your marital settlement negotiations to ensure that you are as prepared as possible for the financial scenarios of pre-retirement and retirement. The time to address these issues is during the negotiations stage when you have a better chance at ensuring financial security for your retirement. It may not be easy, but even being aware of how these considerations may impact you both personally and financially, is the first step at being prepared to make good decisions as you finalize your divorce in your later years.
