Tips for Equitable Division
The level of satisfaction and ability to restart one’s journey after divorce is highly dependent upon how they fared during the divorce emotionally, mentally and financially. This article focuses on tips for managing the financial aspects of the divorce that will help parties regain their financial footing and be able to build on it going forward.
One of the biggest concerns is the marital home because of the memories and sentimental attachment that parties have to the home. Often, one spouse desperately wants to keep the house at all costs, making it a poor financial decision in most cases. The house, while considered an asset to most people, is really a liability. While an investment asset may have minor expenses annually for management of the account or built in expenses for the fund or ETF, a house has ongoing expenses that can far exceed the costs associated with investment securities and fixed income instruments.
First there is the mortgage payment, taxes, insurance costs (which in California have doubled or tripled in the past few years as insurance companies have left the state), routine maintenance for housekeeping and grounds, other maintenance of appliances, fixtures, and structure, and repairs. Lastly, there is the planning and saving necessary to be prepared for the larger capital expenditures such as roof, window, hot water heater, or HVAC replacements that are inevitable even though in the future. The ash outflow associated with the cost of ownership of a home oftentimes is not considered when making an “equitable” division of assets.
Investments in retirement or brokerage accounts are liquid. They are available as you might need the funds either now from the brokerage, or as a loan from qualified retirement accounts. Unlike real estate that is illiquid, there is more optionality with investments in securities that can be sold as needed. When agreeing to forfeit that liquidity and stability for the sake of a home, a cost/benefit analysis should be done to ensure that the decision to keep the home is an equitable one both now and in the future. With real estate, it is market dependent. There may be a potential for lack of similar growth in the appreciation of a residence in a particular area vs. a portfolio of securities. There are also tax consequences to selling both that need to be considered. And there is the cost of ownership that does not accompany investment securities to the same degree as the marital home.
Equitable division considerations come into play for life insurance policies. One party may have a desire for less risk and greater peace of mind that may be associated with life insurance proceeds to protect a future generation or ensure ongoing maintenance if the source of child or spousal support is no longer around. Universal and whole life policies have a cash value, as well, that may be tapped in an emergency. One party may value this asset more than the other party and it is justifiable to consider the security and peace of mind component in determining what an equitable division may be.
When making the decisions regarding certain asset classes versus others, beware of the tax treatment of certain accounts. Non-retirement gains may be taxed typically at capital gains rates which are lower than individual tax rates for long-term gains. Retirement assets are taxed at ordinary rates upon withdrawal. To assess the equality between a dollar in one account vs another, the after-tax value should be taken into account. The tax impact could be considerable as one’s tax rate in retirement may be even higher than expected with required minimum distributions from traditional retirement accounts.
Within any given asset class there are varying tax rates as well. For example, Roth IRAs do not have required minimum distributions and are withdrawals are tax free. In comparison, traditional IRAs and 401(k) plans do have required minimum distributions and assets are withdrawn at the person’s income tax rate. Furthermore, if assets are withdrawn from IRAs before age 59 ½ , thre is a 10% penalty. But this can be waived with withdrawals from 401(k) plans incident to divorce. Adjustments to the value of these funds should be made when considering equitable division of assets.
Equity compensation such as Incentive Stock Options, Non-Qualified Stock Options and Restricted Stock Options, all have varying tax treatments by the IRS. Understanding a party’s interest in the actual options as well as how they will be taxed is imperative to obtaining an equitable division of equity compensation.
Not only is there the risk that the employee spouse may leave the company and the unvested RSUs might expire upon termination, but there are other considerations as well. There is also an emotional component of being tethered to the employee who has been awarded these community/marital options. Typically, these are not transferable until vested or exercised; it depends on the Summary Plan Document. In many cases, the employee must hold the shares or options and release them only as they vest or are requested by the other ex-spouse. The constant connection into the future post-divorce may make these less palatable to one or the other spouse and that should be factored into the decision about equitable division.
Ownership of the 529 accounts may be considered community property in California and marital property in Michigan. These are subject to division or to being confirmed to the children and not divided. Beyond the already funded accounts, decisions about who will continue to fund the 529 plan or college costs are significant to the divorce outcome. College costs and college funding are topics that are typically not considered in the court, but ones that can make a huge impact on the financial security of either of the parties and on the children’s financial future. Equitable division of assets applies to who will be responsible for these future costs.
Retirement income planning should be considered when dividing assets. One spouse may be reliant upon the Social Security work record of the spouse who may have a longer track record at a higher income. If the marriage lasted 10 years or more, and the claimant is 62 or older and is unmarried, and divorced for 2 or more years, the claimant can receive up to one-half of the ex-spouse’s benefit depending upon his/her age when commencing benefits. This does not affect the employee spouse who still will receive 100% of his or her benefits regardless if their spouse claims on their work record. However, if claimed early (less than full retirement age) the spouse who would have been entitled to receive one-half of the benefits may only receive thirty percent. It is also important to compare the inequality of one spouse receive half of the benefits while the other receives the full benefit.
There are many facets to achieving an equitable distribution of property in divorce. And there are many nuances within the categories of assets that need to be divided. Careful consideration should be given to the analysis of how to divide assets equitably from both a quantitative and qualitative point of view.
This article does NOT constitute legal advice and is for general information purposes ONLY. Prior to making any decisions, seek legal counsel from a licensed attorney.
