At times it may seem that the divorce process is masked in a shroud of mystery. Anyone who has been through the experience can attest to the fact that the process has its challenges. Some couples are lucky enough to part ways amicably and maybe remain friends. Others may experience something completely different, and in some cases both parties can become adversarial towards each other. No matter what your current situation is, there are multiple resources that can help keep financial disputes at a minimum. This article will highlight some financial solutions that should be discussed between the client and their divorce attorney as they negotiate different settlement agreements.
Before you become too involved in divorce proceedings, it is important to assemble a quality ‘Divorce Team’. What is a divorce team you ask? In the same way a musician in a orchestra has an individual role that contributes to a larger ensemble, so do the members of your divorce team. In many cases the initial members of your team will be your divorce attorney, their legal support staff, and maybe a counselor when appropriate. For more complex cases, or for those involving liquid assets in excess of $250,000, the team may expand to include other attorneys, accountants, a CERTIFIED DIVORCE FINANCIAL ANALYST® (CDFA®), a mediator or arbitrator, and other professionals deemed appropriate by your attorney. Traditionally your divorce attorney will take the lead and interact with your ex-spouse and/or their attorney on your behalf. The other members of the team will play a supporting role and work with you and your attorney to provide relevant information pertaining to your case. However, there is one member of this team that will eventually become critical in helping you and your attorney evaluate different divorce financial solutions. That member is the CDFA®.
Divorce Financial Solutions
It goes without saying that divorce cases are rarely ever identical. There are many cases with similar points of contention, but like a fingerprint, they are all different. Regardless of how complicated your divorce may be, there are some important financial considerations you and your attorney should discuss as your proceed through the divorce process. For example, consider asking your attorney some of the following questions:
- What state statutes govern the divorce process(i.e. community property or common law state)?
Based on your experience, how are financial and personal use assets divided in this state?
If alimony will be paid to one spouse, how is it calculated? If it is negotiated into the divorce decree, how long can someone expect it be paid?
- If children are involved, who will have primary physical custody and how will child support be calculated?
How should a pension of future payments be calculated, valued, and divided in a divorce?
- Should a property settlement note be used to divide an illiquid asset, like a closely held business or an alternative investment?
Each of the above questions come with a myriad of financial solutions that can be used to assist with resolving disputes. In order to appropriately select the best solution, the CDFA® on your divorce team becomes critical in forecasting the impact of a property settlement agreement after divorce. In order to create a thorough projection of your potential settlement, the CDFA will begin by compiling your entire financial life into a few documents (i.e. cash flow statement, balance sheet, goal statement, insurance assessment, and much more). Then the final assessment will provide an impact analysis that can be used by your attorney to address the questions listed above and many others. Let’s discuss examples of how the above questions can impact your life after divorce.
Community Property vs Common Law
Each state institutes a set of statues that govern how all assets will be titled as they are accumulated. This titling of ownership will later govern how those assets will be divided in the case of divorce or death. The following definitions from FindLaw.com provide a high level overview of the differences. For a deeper understanding of these laws we encourage individuals to consult with an attorney in their state of residence.
“The common law system provides that property acquired by one member of a married couple is owned completely and solely by that person. Of course, if the title or deed to a piece of property is put in the names of both spouses, however, then that property would belong to both spouses. If both spouses' names are on the title, each owns a one-half interest.”
“The states having community property are Louisiana, Arizona, California, Texas, Washington, Idaho, Nevada, New Mexico, and Wisconsin. Community property states follow the rule that all assets acquired during the marriage are considered "community property". Marital property in community property states are owned by both spouses equally (50/50). This marital property includes earnings, all property bought with those earnings, and all debts, accrued during the marriage.”
Now that we have a basic understanding of how different states classify marital property, an individual can begin negotiations. While the aforementioned definitions provide a high level interpretation of the laws, a quality divorce attorney can use this information to make an argument for an alternate interpretation. Furthermore, after a CDFA® has conducted their assessment of the household assets, the attorney can work with their client to determine which asset is of priority. In other words, if one spouse wants the house with a lot of equity then the CDFA® can determine which of the other assets is a comparable substitution for the lost equity. The last thing anyone wants is to be stuck with a larger tax bill, or an unplanned inequitable distribution after the divorce is finalized.
Interpreted and governed by each state, alimony is usually not a guaranteed event. Over the last couple of decades there has been a shift away from mandatory support obligations to determining qualifications for support. The rationale being that both parties have worked, or are able to work, therefore making an argument for permanent alimony much harder to support. However, there are circumstances in which transitional alimony is justified, but those circumstances are usually based in immediate financial needs. For further details about alimony we always encourage our client(s) to seek the counsel of their attorney before forming an opinion.
In the event that alimony is expected to be provided, then it is possible to negotiate that the payments be made for a specific period of time. This can allow the receiving party to maintain a certain standard of living while transitioning back into society. Alternatively, the payment time period can be linked to predetermined adjustments in the financial well-being of the receiving spouse. In this scenario, if the receiving spouse’s income exceeds a certain level or if the receiving spouse co-habitats with another person then the alimony payments would stop.
It is important to note that in cases where alimony drops significantly over the first three years after a couple’s divorce, both spouses could be subject to ‘Alimony Recapture’ rules. Being subject to these rules can create a significant tax liability for the paying spouse. For this reason it is wise to work with qualified professionals who understand alimony recapture when negotiating alimony payments.
Pensions and Illiquid Assets
Another divorce financial solution used in many divorces relates to illiquid assets. In the cases where a household has invested in real estate, private placements, or owns a small business, there may be few options for liquidating that asset. Therefore, an alternate solution is needed to properly divide these kinds of assets. In these situations a property settlement note can be used by one spouse to buy out the other spouse from their interest in the illiquid asset. Additionally, this note can be assigned a market interest rate if paid out over a period of time. There are some drawbacks to using a property settlement note. For example, making sure the person initiating the buy out maintains the ability to pay is essential. It is always advisable for a client and their attorney to understand the drawbacks before agreeing to the settlement note.
As we discussed earlier, each state’s laws determine which assets and income are included in the marital estate. This may mean that someone’s pension may be included in the marital estate. The same concern for illiquidity mentioned above applies to pensions; however there are a few points every divorcee should be aware of before negotiating for the pension.
- A private, or government, sponsored pension is essentially a promissory note by an organization to pay a stream of income for a period of time.
The promissory note is usually calculated based on three factors: how long an individual works for the organization, their highest three salary years, and an assumed growth rate.
The pension payment is entirely based on the employee remaining with the organization until payment date to maintain full eligibility. If an employee terminates employment early then their pension payment could be impacted.
- Unless backed by the full faith and credit of the US government, pension payments are not necessarily guaranteed. In cases of bankruptcy pensions can be reduced or even lost depending on a variety of factors. Examples like Enron, MCI Worldcomm, and General Motors remind everyone that pension benefits can be adversely impacted by bankruptcy.
Now that we have a basis for understanding how a pension payment is determined, we turn our attention to assessing the value of a pension in the divorce proceedings. If a client decides they want to pursue their spouses pension, then it becomes very important for the CDFA®, or a valuation expert, to perform a present value calculation. This requires the analyst to determine the present value of the future cash flow payments that will be paid at some point in the future. The result of this calculation can help the attorney and their client decide if a buy-out of future income is worth the risk of waiting to collect funds at some date in the future. If the buy-out is opted for, and agreed to by both parties, then this becomes an example where a larger percentage of marital assets, today, can be shifted from one spouse to another.
This article does not constitute or replace any legal advice. Rather, this article should be used in a discussion with a divorce attorney to discuss examples of divorce financial solutions. If an attorney is not completely versed in the nuances of the topics discussed in this article then it may be time to expand the ‘divorce team’. When appropriate, we advise clients to speak with a divorce attorney and a CDFA® when evaluating different settlement options.