Numerous studies suggest that women often defer to their spouses when it comes to making long-term financial decisions, a choice that can put them at a distinct disadvantage in the event of divorce or death of a spouse. Our posts today and tomorrow will focus on the role financial advisors can play in helping their female clients successfully navigate these life transitions.
Divorce is likely to significantly interrupt a woman’s financial path at whatever age it occurs. While divorce rates for younger couples are steady or declining, research shows that “gray,” or late-life, divorce is rising. According to Pew Research, the number of people age 50 or older getting divorced had doubled in the past 25 years (see chart). For some couples, that could mean unraveling assets and finances that have been shared for decades.
As an advisor guiding women through financial change after a divorce, what should your conversations include? If your client has previously ceded control of major financial decisions to her spouse, she’ll need a lot of information, including help understanding the division of marital assets, income considerations, and estate planning.
Download “Achieving Financial Fitness: A Checklist for Your Female Clients,” and you’ll be ready to help your women clients prepare for the financial road ahead.
Division of Marital Assets
This topic can become highly complicated when guiding women through financial change after a divorce. Assets acquired during marriage are split according to state law. In the nine states that have community property laws, assets acquired during marriage are considered owned 50 percent by each spouse, with certain exceptions. Similarly, debts acquired during the marriage are generally attributable to both spouses. In noncommunity property states, debts usually stay with the spouse who incurred the debt, unless the other spouse cosigned or otherwise guaranteed it.
Retirement savings. Contributions to employer-sponsored retirement plans and IRAs made during marriage are generally considered marital property, with some exceptions. Contributions made outside of the marriage can be considered separate property. Qualified plans, such as pensions or 401(k)s, should be divided pursuant to a qualified domestic relations order (QDRO). A QDRO allows for a tax- and penalty-free transfer to a nonowner ex-spouse. Neither the original owner nor the divorcing nonowner should be taxed or penalized if the nonowner rolls the assets directly into a qualified plan or an IRA. If the nonowning spouse receiving the distribution uses the funds in any other fashion, a tax will be imposed on that distribution, but only to that spouse.
Early discussion of the QDRO can be helpful to the nonowner spouse, as options can vary from plan to plan. Pensions, for example, will generally not pay a lump sum but will make payments to the ex-spouse the same way they would be made to the employee-owner. The sooner a QDRO is presented to a plan administrator, the clearer the understanding a divorcing spouse will have over her options.
Dividing an IRA in divorce is usually determined on a state-by-state basis and does not require a QDRO. For federal tax purposes, if the division follows a court-issued divorce decree and is made as a transfer to the ex-spouse, as opposed to a distribution, an IRA owner can avoid tax and penalty. Once the asset is transferred, each spouse becomes solely responsible for tax and penalties of any future distributions.
Family home. If one spouse desires to hold on to the home, the marital estate can be equalized from other assets if necessary. Factor in ongoing mortgage payments, property taxes, and maintenance expenses into your client’s cash flow and long-term financial plan to see whether it’s feasible to provide ongoing upkeep of the property or look into alternatives, like downsizing.
Life insurance. The accumulated cash value of a life insurance policy is subject to division much like any other marital asset. Transfer of a policy’s ownership can be part of a divorce decree if it’s necessary to divide the cash value. If your client owns a policy and doesn’t wish her ex-spouse to receive the death benefit, she should change her beneficiary designations.
In the division of marital assets, income may need to be equalized if one spouse was the overwhelming breadwinner. State family laws determine any alimony amounts. Whether your client will be paying or receiving alimony payments, the impact on her monthly or annual cash flow should be factored into the financial plan.
Alimony. Under the Tax Cuts and Jobs Act of 2017, alimony payments are no longer deductible by the payer, and, consequently, the payee can’t include the money as taxable income. This change applies to divorce settlements made after December 31, 2018. It can also apply to existing agreements that are modified after that date but only if the modification explicitly states that the new rule applies.
Social security. Your divorced client may be able to collect social security income on her ex-spouse’s working record (even if the ex-spouse has remarried) as long as she has not remarried, the marriage lasted more than 10 years, and the couple has been divorced for more than two years. She and the former spouse must be 62 or older for her to qualify. If she was born before December 31, 1953, she can file a restricted application allowing her to receive up to 50 percent of her ex-spouse’s full retirement age benefit amount, while her own benefit can grow with delayed retirement credits. If she’s hesitant to explore this option, you can reassure her that her ex-spouse won’t be aware of her claim and does not need to be involved.
Child support. This highly sensitive issue is usually hashed out in court, but if your client retains custody, even partial custody, the guardianship of the minor—both the child and the child’s estate—should be addressed in her estate planning documents. The divorce decree should determine amounts, if any, of child support paid from one spouse to the other and dictate who will be entitled to claim the children for tax purposes. Children’s social security benefits may be available for an unmarried ex-spouse of any age who is caring for a child younger than 16.
To accommodate any adjustments following a divorce, encourage your client to update her estate plan. She may need to amend or get new trusts, wills, and powers of attorney, as well as change beneficiary designations. If the former spouse was named as her trusted person or beneficiary in documents or on accounts, these designations should be changed as soon as possible.
Taking the Long-Term View
There is a burning need for long-term planning when guiding women through financial change after a divorce. Many married women lack a comprehensive view of their finances. In a Fidelity Investments survey, only about one-third of divorcées felt financially prepared for the breakup of their marriage (see the chart below).
In addition to encouraging estate planning, emergency savings, and health care plans, an advanced strategy should ensure protection against a loss of income with adequate insurance for health, life, and disability. Disability insurance can provide necessary income replacement when a single woman has no partner to step in, and a single woman with children can use life insurance to protect the needs of those under her care after her death.
Do you have any additional tips for guiding women clients after they’ve gone through a divorce? What financial planning topics do you think are most important? Please share your thoughts below!