Tag Archive for Divorce

Ask the Advisor: What you Need to know About Divorce and Money

I recently received a question from someone who wishes to remain anonymous: he and his wife are considering separating and he was wondering about his next step financially – specifically about relocating and what his options are.

 

Divorce is an unsettling time and one of the biggest concerns is where to live.  And this is a question I have had often from recently divorced people:

 

Should they use their portion of retirement accounts to buy a new house?

 

If a large part of your divorce settlement comes in the form your former spouse’s retirement accounts, it can be tempting to use that money for a down payment on a new house.  Here is why I discourage this idea:

 

You will take an enormous tax hit:  Say you want to use $50,000 out of a 401(k) plan to buy a house.  You will be adding $50,000 to your annual income for the year (in addition to work and/or maintenance payments) for tax purposes.  If you are under age 59 ½, you also will be hit with a 10% early withdrawal penalty.

 

If you are in the 25% tax bracket, that $50,000 withdrawal will cost an additional $12,500 in taxes plus $5,000 for the IRS penalty.  So, that $50,000 down payment actually costs you $67,500 after you pay the IRS.

 

You sacrifice your future retirement:  Using the example of the $50,000 withdrawal, let’s figure out what you will give up in retirement security by using that money for a house.   Say you are 45 years old and will retire at age 65.  If you average 7%/year growth in a stock mutual fund over 20 years, that $50,000 would be worth $179,000 at retirement.

 

You may not know where you want to permanently settle right after your divorce:  My realtor friends tell me that buyers shouldn’t expect to make money on a home purchase if they are in the home for less than 5 years.  Commissions, moving expenses, and uncertain real estate values make a home purchase a long term investment.

 

Since divorce is a time of adjustment, it’s hard to say where you will want to live 1, 2 or 3 years after the split.  Maybe a new job will require relocation.  There may be child custody arrangements that necessitate a move.  It may make sense to take 6 months or so to rent and see what happens in your life before you commit to a new real estate purchase.

 

Although you are likely feeling unmoored after a divorce, don’t let emotions cloud your smart financial judgement.  Taking money out of a retirement account to buy a house was a bad idea when you were married and that doesn’t change after a divorce.

 

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Financial Do’s and Don’ts of Divorce

financial-divorce-fee-only-financial-planning-denverFirst, let me be clear:  I am NOT a Certified Divorce Financial Analyst.  There are such people out there and I highly recommend you visit one before starting divorce proceedings.  This is just a quick list of things I wish people would do BEFORE they slam out of the house and start sleeping with their spouse’s friends for revenge.

Do’s:

  • Take copies of all of your financial statements.
  • Keep track of the family spending for 2-3 months to see what your likely post-divorce budget will be.
  • Get used to the idea that your lifestyle is about to change for the worse.  Supporting two households is way more expensive than one.
  • Get some counseling lined up for you and your kids.  Budget for it.  This will be a necessity, not a luxury.

Don’ts

  • Cheap out on your divorce.  Pay for a financial consultant, mediator, attorney, or whatever you need to get the process over with as soon and smoothly as possible.
  • Hide assets from your spouse.  The only people who win when you do this are attorneys and forensic accountants.
  • Fight for the family home.  It’s probably got some huge mortgage that you can’t afford on one salary and it’s expensive to keep up.  Let it go.  Start fresh with something you can afford.  The kids will get over it.  See bullet #3 above.

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