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How To Avoid Making A Financial Mistake In A Divorce Settlement Thumbnail

How To Avoid Making A Financial Mistake In A Divorce Settlement

In many cases, a divorce can result in anger, hurt, confusion, depression, and even self-blame. These upsetting circumstances can make it difficult to remain objective and can cause people to make emotionally-charged decisions that may hurt them financially.  

It isn’t uncommon for women to experience career interruptions due to childbirth, caring for aging parents, or taking time off to assume household responsibilities. This often results in lower lifetime earnings and less Social Security benefits than male counterparts.

This makes it even more imperative that you are able to negotiate the best terms for yourself during the divorce settlement. It may sound overwhelming, especially if you haven’t been involved in your family’s finances in the past, but the decisions made in the divorce settlement lay the foundation for your life moving forward. Avoiding financial mistakes during a divorce settlement can ensure that you’re set up for success in the following weeks, months, and years after your divorce.

Have a good understanding of the household finances

If you aren’t involved in the household finances, now is the time to start making yourself aware. 

First, make sure you have access to all of you and your spouse’s financial accounts, including your checking, savings, retirement, and investment accounts. You should have your own login credentials so that you can’t lose access in the event that your spouse tries to lock you out.

Get a good idea of your net worth, your spouse’s net worth, and your combined net worth. 

Make two copies of your records and give one to your spouse. This is important because even if your spouse is amicable now, you should always anticipate rough patches. 

In some situations, one spouse may refuse to release documents unless they’re legally forced to do so. This is especially likely if one spouse controlled the household finances. So, if you already have copies of your financial documents, you can avoid this problem.

These records will also be used by your attorney to decide how to divide your assets and debt and determine whether you should pay spousal support. 

Divide your assets

You should do this right away. Even though divorces can be dragged out for months or even years, you need to start protecting your investments and assets as soon as the separation is in motion.

Separating assets allows you to keep your eye on your money. If you continue to use joint accounts, your spouse could drain these resources and you could be left with nothing.

The splitting of financial assets is somewhat guided by the laws of your state. In Minnesota, all marital property shall be divided equally between the divorcing spouses. 

Marital property consists of all property owned by the spouses that is not classified as non-marital property, which consists of any property that a spouse owned prior to the marriage; that a spouse inherited at any time; or that was gifted directly to one of the spouses. If property is classified as non-marital, then that spouse is entitled to it, without having to divide any portion.

You and your spouse may also choose to come to an agreement on your own. To do so, work together to make a list of all of the items you own jointly. Then, value each item. You may choose to only assess items over a specific value, say $200.  If you own a house or anything that's difficult to value, get an opinion from an outside authority. Then, review your list and decide who each item belongs to. If you are able to reach an agreement, you will present it to a judge. The court will normally approve of your agreement, unless it’s clear that one party appears to have agreed to receive way less than half of the property value. 

Properly split your retirement accounts

Depending on the type of retirement account you have, there is a separate division process. IRAs are divided using a process known as "transfer incident to divorce," while qualified plans, such as a 401(k) and 403(b), are split under the "Qualified Domestic Relations Order" (QDRO).

QDROs and “transfers incident to divorce” are both tax-free transactions as long as they are reported correctly to the courts and IRA custodians. There is a 10% early withdrawal penalty if retirement accounts aren’t transferred via a divorce decree or legal separation agreement. Lack of attention to detail can make the divorce process much more complicated and expensive.

Qualified Domestic Relations Order (QDRO)

A QDRO is a judicial order that splits a qualified retirement plan by recognizing joint marital ownership interests in the plan. A QDRO's recognition of spousal ownership interest awards a portion of the benefit to a spouse.

The receiving spouse may roll QDRO assets into their own qualified plan or into a traditional or Roth IRA, in which case the transfer will be taxed as a conversion but not penalized.

If the transfer from a qualified plan pursuant to a divorce settlement is not deemed a QDRO by the IRS, it is subject to tax and penalty.

Transfer Incident To Divorce

A “transfer incident to divorce” is used to split an IRA account.

The movement of funds may be classified as either a transfer or a rollover by the IRA custodian, depending on the circumstances.

The recipient will take legal ownership of the assets when the transfer is complete and assume sole responsibility for the tax consequences of any future distributions.

Provide the IRA custodian with a copy of the divorce decree that plainly states how assets should be transferred from one account to another. If the division agreement is not approved by the courts, you will owe both tax and an early withdrawal penalty on the entire amount that the recipient received.

Pay off your debt

Often, even more difficult than dividing property is deciding who will be responsible for any debt that has been incurred during your marriage.

Even if you trust your spouse, order a credit report from each of the credit reporting agencies: EquifaxExperian, and TransUnion. Your credit report breaks down everything you owe, including credit card loans, vehicle loans, mortgages, and credit card debts.

Go through each credit report and identify which debt is shared and which is in your spouse's name only.

At this point, it's important to stop the debt from growing any larger. 

The best way to do this is to cancel joint credit cards. Even if you and your spouse have an agreement to pay them off, your spouse could abandon their responsibility toward the debt and you’ll be left to pay the balance.

It only takes a few minutes to cancel your credit cards, but in that same amount of time your spouse could charge $10,000 to them. As long as your names are attached to the card, you will both be responsible for that credit card debt, no matter if you’re separated or not.

If you have the money to pay off your joint credit cards, do so and then close the accounts. If you don’t have the funds, divide the debt in half and transfer it to your individually held cards and cancel the jointly-held ones.

Once you've identified your debts and taken steps to ensure they don't increase, you’ll need to decide who will be responsible for what.

If possible, pay off the debts now. If you have savings or assets you can sell, you can pay off what you owe and start your new life debt-free.

Agree to take responsibility for the debts in exchange for receiving more assets from the division of property. Or, agree to let your spouse take on the debt in exchange for receiving more assets.

Start living financially independent

Don’t base your financial future on alimony or child support. Relying on payments from your spouse can have devastating consequences if you aren’t prepared to support yourself on your own. Neither is guaranteed, and you don’t want to be caught in an unfunded or insecure situation if the payments stop coming.

Make sure you have a plan in place for your own long-term financial success. To do this, start by creating a budget and determining your financial goals. Whether you need to look for areas to cut down on costs, find new employment, start an emergency fund, go back to school, or pay off debts, your situation likely looks much different than when you were married.

Having this plan in place now will help you make smarter financial decisions in the coming months.

Advocate for yourself

Though you may know your spouse, keep in mind that divorce can bring out the worst in people. Even the most honest people may try to deceive their spouse when it comes to figuring out finances during a divorce settlement.

Be prepared to advocate for yourself.

To best prepare, educate yourself about your financial situation in the event that your spouse attempts to underreport income or hide other financial details.

Then, start building your team of financial advocates. A financial planner will help organize your finances, understand where you stand financially, and plan for your future.

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