Divorce affects millions of families, and dividing finances can play an enormous (and sometimes contentious) role in the process. Luckily, there are steps you can take to protect your finances both during and after divorce.
One of the biggest areas of confusion involves debt. As soon as you can, pay off (even if you have to do balance transfers) all joint credit cards and cancel them. Replace those with credit cards in just your name, so your spouse can’t run up debt that you will be responsible for. Some couples obtain individual personal loans and pay off their portion of the joint debts so the accounts can be closed. If that’s not possible, inform your creditors immediately in writing that you’re going through a divorce, and that you would like your revolving credit accounts frozen.
Be sure to consider how divorce will impact your health insurance. If you have coverage under your spouse’s policy and he or she works for a company with more than twenty employees, you’re eligible to continue under the same plan for up to thirty-six months by electing COBRA coverage. You’ll have to pay the amount the coverage costs the employer plus an administrative fee of 2 percent, which can get quite expensive. If you don’t notify your spouse’s employer of the divorce within sixty days, you lose your right to this benefit. Losing coverage through divorce also allows you to obtain coverage through the Affordable Care Act (ACA) as a special enrollment period.
If your marriage is headed for divorce and you’re the custodial parent, file for child support as soon as you and your spouse separate. Your spouse has no legal obligation to pay child support unless there’s a court order from a divorce, marriage dissolution, establishment of paternity, or legal separation. An attorney or your local child support agency can help you get a court order. Child support judgments are issued as of the date of filing and are not retroactive.
Unfortunately, having a court order is not always enough. According to the US Census Bureau, only 44 percent of custodial parents receive their full child support payments regularly, and around $33 billion of court-ordered child support remains unpaid. There are routes you can take if your ex is behind on child support, but the best way to protect your family financially is to not depend on that money to cover your necessary monthly expenses. Find other secure sources of income that you can rely on to pay your bills. Even if your ex pays on time all the time, and your split is relatively amicable, situations can change and disrupt those support payments (think job loss, illness, remarriage).
That doesn’t mean you shouldn’t try to recover back child support if your ex-spouse is delinquent. The federal Office of Child Support Enforcement (www.acf.hhs.gov/css) offers detailed information, advice, and support for collecting back child support.
Like all other assets in a divorce, retirement savings normally get divided. How the money gets split depends on a variety of factors, from the presiding state law (wherever your divorce proceedings take place) to relative income levels. Regardless of how the numbers work out, it’s important to follow all the steps necessary to split the assets without triggering current income taxes and tax penalties, and losing a huge chunk of that money as a result.
A QDRO (qualified domestic relations order) is a special legal document that spells out how retirement plan assets will be split in a divorce. The court issues a QDRO and serves it to the employer of the spouse with the plan. That way, the spouse with the plan won’t have to pay income taxes on the withdrawal. Plus, with a properly executed QDRO, the money taken out of the plan won’t be subjected to the 10 percent early withdrawal penalty that normally hits premature distributions from retirement plans. And with a substantial retirement nest egg, that 10 percent could translate to an enormous amount (for example, on a $500,000 retirement account, the penalty alone would come to $50,000!).
QDROs must contain specific information in order to be valid, so you can avoid that nasty 10 percent penalty. A proper QDRO will include the following:
You can find more details about QDRO language on the US Department of Labor website at www.dol.gov.
Creating a QDRO for defined contribution plans like 401(k)s or IRAs (Individual Retirement Accounts) is pretty straightforward. Things get more complicated when defined benefit plans are involved. The calculations for defined benefit plan payments are complex and based on a variety of factors (length of service and life expectancy, for example), so the QDRO calculations are also pretty intricate. In fact, it usually requires an actuary or other retirement benefit specialist to figure out each spouse’s fair share of the plan assets. On top of that, the payout terms in the QDRO can’t be different than the plan’s own payout terms.
Many ex-spouses who receive payouts from retirement plans don’t put that money back into retirement savings; rather, they use the money to cover current expenses. If the money is not put into a retirement account, it will be subject to current income taxes (unless the money is coming out of a Roth IRA account). For example, if one spouse receives $50,000 from the other spouse’s plan and doesn’t roll it into a retirement account, the plan manager will automatically take 20 percent for tax purposes (sort of like withholding taxes on a paycheck). That’s to cover the potential income taxes on the $50,000, which will be determined by that spouse’s overall financial situation at tax time.
But if that money goes straight into a retirement account, current income taxes won’t apply until the money is eventually withdrawn. That offers two important financial benefits:
Plus, it would be virtually impossible to re-create that retirement savings if the money is used to pay for current expenses. Eventually saving up another $50,000 (or whatever the amount) over time won’t give retirement savings the same momentum: A great deal of compounding time will be lost.
The Roth IRA Factor
When splitting retirement accounts, remember that they’re not all treated the same for tax purposes. How the account will be taxed in retirement can significantly change its fair value. For example, a $50,000 Roth IRA will be worth more than a $50,000 traditional IRA because the Roth IRA funds will be tax-free during retirement and the traditional IRA funds will be taxed.
If you’re divorced, you may be entitled to receive Social Security retirement benefits based on your ex-spouse’s earnings. Qualifying for the benefits depends on your specific situation and whether you meet all of the following conditions:
If you meet all of those criteria, you’ll receive up to half of your ex’s full benefit. The benefits you get have no effect on the benefits that your ex-spouse gets. The opposite holds true too: If your ex-spouse claims Social Security based on your benefits, it won’t have any effect on yours. Plus, neither of you can keep the other from collecting those ex-spouse benefits. In fact, your ex doesn’t even need to know that you’re claiming benefits based on his or her earnings history. If you’ve been married and divorced more than once, you can choose whichever Social Security benefit gives you the biggest payout (your or your ex’s benefits).
To avoid getting reduced retirement benefits, wait until you reach your full retirement age (FRA). While you can start getting Social Security payments at age sixty-two, the monthly check will be smaller than if you wait until at least your FRA to start. Your FRA is based on your birth year, and you can find that information on the Social Security website at www.ssa.gov. For example, the FRA for anyone born in 1960 or later is sixty-seven.