The raw emotional cost of a divorce is impossible to put into numbers. The financial costs, however, are far less abstract. When you include the liquidation and splitting of assets, the payment of legal fees, and the investment needed to regain a solid financial footing, the bill can quickly add up. So it's wise to build a team of strategic allies who can help you sort out the practical details.
Whether you're getting divorced, recovering from one, or watching it unfold for a friend or family member, consider these steps for minimizing the financial consequences.
Take the right precautions
The single most effective divorce tool is a carefully drafted prenuptial agreement. Although entering a marriage with an exit strategy may seem calculating, those who are getting remarried are especially likely to entertain the possibility and bring up the conversation. In fact, while a prenup may not be for everybody, many couples can benefit from having one. "A prenup is generally good insurance," says Arlene Dubin, a Manhattan-based matrimonial attorney and author of Prenups for Lovers: A Romantic Guide to Prenuptial Agreements. She recommends not only spelling out what would happen to key assets like real estate, retirement plans, investment portfolios, bank accounts, business interests, inheritances and gifts, but also — perhaps most importantly — dealing with major debts.
While a prenup may be a sore topic during the heady days of an engagement, Dubin believes it can start a deeper discussion about a shared life going forward. Will there be children? Will both members work? How much do they intend to rely on existing assets, and how do they plan to build assets together? "This should be an exercise in mutual discovery," Dubin says.
Prenups come in many varieties, she observes. An agreement might outline how to deal with debts incurred before and during the marriage; how a personal or family business will play into the couple's lives, and what death or divorce might mean to that; or how the couple will treat gifts, inheritances or trusts that benefit either spouse.
Know what's at stake
When a marriage is ending, the first financial shock to face — often nonnegotiable — is the cost of the divorce itself. "It can be a huge drain on resources," says Stacy Allred, director, Wealth Structuring Group at Bank of America Merrill Lynch. "You're already splitting assets. When you add a really messy divorce with high legal fees, it becomes a considerable financial and emotional drain." Allred adds that it's vital to have someone on your side who has a handle on a financial exit strategy that meets your needs both now and down the road.
Start with a complete inventory, which will help you better understand what you're entitled to receive or retain. Assets should include retirement plans, savings and checking accounts, properties and pensions, business interests, and inheritances. In addition, be sure to list any financial obligations or debts that you and your spouse may have incurred. Do what you can to document each item by gathering tax returns, paycheck stubs, wills, trust instruments, bank and credit card statements, insurance policies, property deeds, and brokerage account documents. This is the basis of any decent financial housekeeping, but it's essential during a divorce — arming you with the detailed knowledge you need to make the right financial decisions.
Your fair share
Splitting the assets of your marriage will fall to the lawyers and the legal process. There are, however, tactical steps you can take to prepare. "What I tend to recommend is to split what you have across all assets as opposed to a scenario where you take the house and I take the cash," Dubin says. That kind of apples-to-oranges thinking can backfire, she notes, especially when some of the assets you're dividing have less liquidity than others or are more prone to fluctuate in value.
If neither of you has a deep emotional attachment to the family home, selling it could be preferable, says Bill Hunter, director, IRA Product Management at Bank of America Merrill Lynch. The proceeds can be split, or they may be used to pay down debt or cover the cost of the divorce itself. A sale of other shared, nonliquid assets such as artwork, boats and vacation homes may also be advisable.
One important asset, frequently forgotten during divorce proceedings, is health insurance. If you're covered by your spouse's plan, under federal law you can continue that coverage for up to three years by enrolling in Cobra, although you'll be responsible for making the payments. Ask your lawyer whether it makes sense to include Cobra premium costs as part of the settlement.
What to do with retirement accounts
Splitting IRAs and 401(k)s can prove problematic. If either of you has a retirement account, it's vital that you sign a court-ordered qualified domestic relations order (QDRO), which spells out exactly what percentage of the account each of you will receive. Otherwise you won't get paid, regardless of what the divorce agreement states. The good news: This document allows you to roll over your agreed-upon share into another IRA without incurring early-withdrawal taxes, as long as you do so within 60 days of receipt of the QDRO.
Try to avoid tapping your retirement accounts, even if you need cash to pay your divorce attorney. The tax-deferred status of the funds in these accounts lets them compound unimpeded until they're withdrawn during retirement; Hunter says it would be foolhardy to tap them now to pay for manageable current debt. Instead, consider taking a loan at today's favorable interest rates.
A few things on your financial to-do list don't relate directly to the divorce settlement, though they can have a major impact on you and your ex-spouse. You need to update the beneficiaries in your will, as well as the person to whom you're granting a power of attorney should anything happen to you. "I have seen people forget to go back and review things, and years later they discover they have an ex-spouse as primary beneficiary," says Michael Liersch, director, Behavioral Finance at Bank of America Merrill Lynch. "Review all your estate planning documents to make sure they reflect your current wishes."
Also be sure to follow up on any debt you may have incurred during the marriage. Although the responsibility to pay may fall to your ex-spouse, your name may still be tied to the account. This can have repercussions on your credit should he or she default on payment.
Social Security can also come into play. If you were married to your spouse for 10 years or more, you can claim spousal benefits even if your former partner remarries. But Hunter notes that if you remarry, you can't claim the benefits unless your new marriage has ended in death or divorce.
A new start
Once the divorce is finalized, the next chapter begins. Your Merrill Lynch Financial Advisor can help review your financial outlook and create a budget now that you are newly single and may be living on a single income. "Start with what you spent over the past year and try to forecast your new situation and what would be a realistic budget," Allred advises. Divorce can be damaging to your finances, but it is something from which you can recover. Your best bet is to take stock of what you own, stay level-headed, and never lose sight of your short- and long-term financial objectives. "Your goal in the end," Allred says, "is to have a new financial strategy — one based on a new life chapter."
Consider asking your Merrill Lynch Financial Advisor the following questions regarding divorce, remarriage or starting a new life on your own:
- How might a divorce or a new marriage affect my financial situation?
- What steps can I take to help me be financially independent after my divorce?
- Should I fill out an investor profile questionnaire to pinpoint my risk tolerance, investment experience, liquidity needs and time horizon on investments once I'm single?
This article does not constitute legal, accounting or other professional advice.
Any information presented about tax considerations affecting client financial transactions or arrangements is not intended as tax advice and should not be relied upon for the purpose of avoiding any tax penalties. Neither Merrill Lynch nor its Financial Advisors provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.