Top Financial Mistakes to Avoid in a Divorce Settlement

Thinking clearly while under stress is a must

Reviewed by Pamela RodriguezFact checked by Vikki Velasquez

Divorce is a gut-wrenching experience. Whether you have been blindsided by infidelity or had to give an “I still love you, but I’m not in love with you anymore” speech to the person who you thought would be your partner for life, the grief can be profound. And you’re somehow supposed to pull it together through paralyzing pain and heart-pounding rage and make important financial decisions that may affect the rest of your life. 

One of the best ways to regain your sense of self, besides therapy (seriously), is to minimize the financial damage of a divorce and put yourself in the best possible position to start over. Here are a few mistakes that you’ll want to avoid during this time when it’s hard to think clearly.

1. Rushing the Process to Get It Over With

Many divorcing couples want their soon-to-be-ex out of their lives as quickly as possible. This is especially true when physical, emotional, or financial abuse is involved. The problem with a rushed divorce is that it can lead to an unfair division of assets for the more vulnerable spouse. One party may take advantage of the other party’s desire to get things over with and convince them to leave the relationship with less than they deserve and without the support that they need to start over. 

Marriage creates a complex legal and logistical intermingling of assets that can be difficult to sort out. After ensuring your safety, it’s important to go through the proper steps to locate and properly value all of your assets and liabilities with professional help.

2. Refusing to Try Mediation or Arbitration

Mediation and arbitration are two types of alternative dispute resolution that divorcing couples can use to avoid the time, expense, and stress of litigating a divorce in court. These processes also allow each spouse to retain more control over outcomes and keep family matters private, instead of leaving matters up to a judge and allowing divorce details to enter public court records. If you can afford it, it is still a good idea for each spouse to hire their own attorney to look out for their best interests. 

3. Misvaluing Marital Assets

Property can be valued in different ways, especially when it’s a complex asset like a business. That’s why each spouse should obtain their own independent valuation of major assets to make sure that they are divided fairly. A mediator, an arbitrator, or a judge can look at both valuations and help ensure a fair division. 

It also may be necessary to untangle how much of an asset’s change in value occurred after the marriage—for example, in the case of a house that one partner purchased before marriage—to calculate the sum to which each partner is entitled. Also, keep in mind that if you get an asset that requires ongoing maintenance, such as a house, it may be appropriate to factor those additional costs into the divorce agreement.

4. Not Considering the Possibility of Hidden Assets

Through trusts, overseas accounts, and less sophisticated methods, such as transferring assets to trusted family members or friends, spouses may attempt to keep more than their fair share of marital assets in a divorce. Hiring a forensic accountant or an attorney who specializes in finding hidden assets can help you make sure that you don’t lose anything you are entitled to in your divorce. 

An attorney can also help you get a court order requiring your spouse to produce documents or answer about their assets. And financial institutions can be required to produce records of a spouse’s account—if you and your attorney can figure out which financial institutions might be holding your spouse’s hidden assets.

5. Being Saddled with an Unfair Share of Marital Debts

Just as uncovering and properly valuing all marital assets is important, it’s also important to know about all marital debts. Ordering and reviewing copies of each spouse’s credit reports from all three major credit bureaus can help uncover hidden consumer debts, such as credit card, auto, student loan, personal loan, and mortgage debt. Identifying hidden business liabilities—such as bad debts and pending lawsuits—is more challenging but also important.

Responsibility and liability can vary by state because some states are community property states, while others are equitable distribution states. In many cases, creditors can come after one spouse for another spouse’s unpaid joint debts—such as a credit card taken out in both spouses’ names—even if the other spouse had no idea that the debt existed. It’s important to uncover these problems and, whenever possible, pay off all debts or refinance them so that they become the sole responsibility of one spouse going forward.

6. Not Getting Your Fair Share of Retirement Assets

While spouses may each have their own retirement accounts during marriage (these accounts cannot be jointly owned), there may be significant differences in the amount of assets in each account. A qualified domestic relations order (QRDO) allows retirement plan assets to be divided fairly in a divorce, with neither the account holder nor the recipient incurring early withdrawal penalties when receiving the money before age 59½.

The most obvious example where it would not be fair for each spouse to exit the marriage with their own retirement accounts is a marriage in which one partner has been the primary breadwinner and accumulated large sums in a 401(k) plan through work, while the other partner has raised the children full time. With no earned income, that non-employed partner’s only option for retirement savings would have been a spousal individual retirement account (IRA). As IRAs have much lower annual contribution limits than 401(k)s, the working spouse likely has far more retirement assets in their name—if a spousal IRA exists at all. 

Does dividing retirement assets seem too complicated? Ask a certified public accountant (CPA) about the long-term financial consequences before making an agreement like “I’ll keep the house. You keep the 401(k).”

7. Not Thinking Long Term About Child Support

When a divorcing couple has children, an important part of the divorce settlement is ensuring that the children will have the financial (and emotional) support that they need at least until adulthood. Numerous factors go into child support calculations, including each parent’s income, how much time the child will spend with each parent, and the child’s age. 

It’s a mistake to only consider regular, daily expenses in determining how much child support to seek. Make sure to factor in future educational expenses, medical expenses (including health insurance premiums), and extracurricular expenses. A life insurance policy that will provide for alimony and child support in the event of the supporting ex-spouse’s untimely death can be a smart purchase.

The divorce can also affect the child’s financial aid award for college because some schools assume a certain contribution from each parent even if one parent has left the picture. And parents will need to decide who will claim the child tax credit each year, because only one parent can claim it. They also will need to address possible issues with other tax credits and deductions and shared custody.

8. Handling Your Own Divorce

It’s no surprise that family law attorneys will tell you that a do-it-yourself divorce is a terrible idea. But even though they stand to gain financially from saying that, they’re not wrong. 

Trying to manage your divorce yourself means trying to handle a complex legal and financial matter in which you aren’t an expert. The outcome will have a significant effect on your future, and you’re probably not thinking clearly because of the pain and stress of the divorce.

Whether you’re the spouse who’s more likely to concede too much or the spouse who doesn’t want to get taken advantage of, having legal representation can help you get a fair result. Furthermore, even in an amicable divorce, it can be smart to hire a CPA who can help ensure that all assets and liabilities are accounted for, fairly valued, and equitably divided without incurring unnecessary taxes.

FAQs

Is Using Mediation or Arbitration a Good Idea in a Divorce?

Yes, it can be, because it keeps the divorce private, rather than becoming a matter of public record by going to court. It also gives divorcing spouses more control over the outcome, instead of being subject to a judge’s decision. That said, if the divorce isn’t relatively amicable, with one spouse unlikely to bargain in good faith, then mediation or arbitration are probably not advantageous.

How Do You Protect Yourself Financially in a Divorce?

In general, it’s a good idea to close joint credit card accounts so that one spouse can’t run up debt for which the other one will be held responsible. Reviewing your credit reports and monitoring your credit can help you make sure that your spouse hasn’t done anything to damage your credit. Do not take assets that are not yours, because a judge may sanction you heavily for doing so. A family law attorney and an accountant can help you take the specific steps that your situation warrants.

What Are the Tax Consequences of Selling or Transferring Marital Assets?

When selling or transferring assets in the process of dividing them during a divorce, spouses need to be careful to avoid unnecessary capital gains taxes and gift taxes. An accountant can help you follow Internal Revenue Service (IRS) rules about timing and documentation to do a transfer incident to divorce and steer clear of or minimize these taxes.

Another thing to keep in mind is the potential future tax liability of any assets that you receive. Let’s say you get the taxable brokerage account and your spouse gets the retirement account, each of which is worth $100,000 today. Without considering the future taxes that will be due when selling and withdrawing assets from those accounts, this division is likely to be unfair.

Can I Handle My Own Divorce?

Generally, this is not a good idea. Most people don’t have the skills to deal with complex legal and financial matters, and the stress and pain of a divorce—even an amicable one—can prevent you from thinking clearly. Having legal representation may cost more but is definitely worth it.

Read the original article on Investopedia.