FOR IMMEDIATE RELEASE

Date: June 17, 2002

FINANCIAL ISSUES SURROUNDING A DIVORCE
Making the distinction between "even" and "equitable"

ENGLEWOOD, COLORADO—Divorce is an emotionally difficult experience for most couples, but it can be devastating financially, as well, if proper planning is not done before the divorce settlement becomes final.

"In today's complex world, divorce is no longer a simple matter of splitting property down the middle," says William L. Anthes, Ph.D., president and CEO of the Colorado-based National Endowment for Financial Education® (NEFE®), an independent nonprofit foundation whose mission is to educate Americans about personal finance. "A divorce can leave one or both parties with inadequate income, diminished assets, poor credit or tax problems; and, once the divorce is final, these mistakes can be difficult or impossible to remedy."

Following are several areas that anyone contemplating divorce, or already in the divorce process, should pay special attention to, preferably with the help of a financial advisor.

Retirement plans and QDRO

Perhaps nowhere have divorce finances grown more complicated or more important than in the division of retirement assets. Financial planners point out that these often represent the single largest asset in a marriage—larger even than the value of a home—and the most crucial to the future financial well-being of the divorced parties.

Anthes emphasizes that one party should not arbitrarily give up their right to a portion of the other party's retirement assets in exchange for immediate, more accessible assets such as a home. The ability of tax deferred assets to grow is powerful, and both parties will need those assets in retirement. Women, in particular, need to be cautious in this area because they tend to have smaller retirement assets than men as a result of their more limited work history.

The first step is to identify all retirement assets. This might include plans from multiple employers over the years, as well as individual retirement accounts (IRAs) and annuities. Be sure to include less common assets, such as those in a nonqualified deferred compensation plan.

Some retirement assets, such as IRAs, can be easily divided, though the assets must be transferred carefully from one spouse to the other. Otherwise, one party could be hit with taxes and penalties and the other party could lose the ability to continue to grow their share of the IRA tax deferred.

The division of traditional pension plans, 401(k)-type defined contribution plans, tax-sheltered annuities and other similar assets requires a more complicated process called a Qualified Domestic Relations Order (QDRO). This is a formal order from the court telling the administrator of the retirement plan what dollar amount or percentage of assets should be given to the nonemployee spouse.

Several complications can arise with a QDRO, however. Some plans allow for a division of assets, and some don't. Tax laws change regularly, and that can affect which plans can be divided. Prior to 2002, retirement plans for local, state or federal government workers could not be divided; in 2002 and later, QDROs can affect these plans. Be sure to obtain pre-approval from a plan administrator before seeking the QDRO and before agreeing to a settlement.

It's also critical that the court approves the QDRO before the divorce is final or the worker changes plan beneficiaries. If the worker dies before the QDRO is in place, the ex-spouse could lose out on all retirement plan benefits, or at least end up in court trying to save them.

The QDRO language must take into account the possibility that the plan participant could die before payment of benefits start, that the benefits could stop upon the retiree's death or that the "survivor benefit" could go to a new spouse.

Attorneys have failed to file the necessary paperwork, or drafted it improperly. Problems may quickly become evident with plans, such as a 401(k), whose assets can be divided immediately; however with a traditional pension plan, problems may not surface until years later when the employee finally retires.

And don't overlook Social Security benefit rights. A person married for at least 10 years before a divorce may qualify to receive benefits based on his or her spouse's employment. But the marriage must last a full 10 years. A day short and the person would lose this entitlement.

Equitable division of marital assets

Generally, property acquired during a marriage is marital property regardless of whose name it's in. Property acquired before a marriage—and that is kept separate in the marriage—is treated as separate property and not subject to division during the divorce. But this, too, can get complicated. For example, profits that separately owned property might earn during a marriage may be treated as part of the marital assets. Precise treatment of property will depend on state laws.

Stocks options also can be overlooked or tricky to divide. Some companies don't allow stock options to be divided between parties. If that's the case, the stock-option holder should offer equivalent assets to compensate the other party. This illustrates the difference between an equitable division of property and an even division of property in a divorce.

The parties also must take tax liabilities into account. Consider, for example, $100,000 of taxable stock and a $100,000 traditional IRA. Withdrawals from the IRA will be subject to ordinary income-tax rates (and possibly penalties if withdrawn before age 59½), while only the earnings of stock and not the original investment, are subject to tax. Furthermore, those earnings may be subject to a much lower tax rate than the IRA withdrawals. Consequently, the two assets may be "even" in current dollar value but not "equitable" in their future after-tax value.

Insurance issues

"Special attention needs to be paid to life, medical, disability and other forms of insurance," stresses Anthes. "Otherwise, an ex-spouse could find himself or herself missing a valuable resource in the event of a future financial crisis."

Divorcing spouses often forget to drop their ex-spouse as the beneficiary on their insurance policy. Some state divorce laws will rectify that problem if one of the parties dies without making the change. But not in all states. In that event, your ex-spouse, instead of your new spouse or other heirs, could receive your life insurance benefits.

The former spouse paying alimony or child support should have and maintain sufficient life insurance and disability insurance to ensure that support continues in the event of death or disability. "It's not uncommon for the survivor to learn the ex-spouse had simply quit paying premiums along the way without telling anyone," says Anthes. "You may even want to own the policy yourself and pay the premiums, with the stipulation that the ex-spouse pays you back."

A divorcing spouse covered under the other spouse's medical plan needs be sure to avoid any lapses in coverage. An ex-spouse (and children) usually can continue coverage under the working spouse's plan for up to 36 months after the divorce under a federal law called COBRA. However, you'll have to pay the full premiums. Sometimes individual or short-term medical coverage is more affordable.

Look to your own employer's plan even if you're not currently enrolled. You may have to wait for open enrollment or you may be able to enroll right away due to the divorce.

Home, sweet home

"Keeping the home is often one of the biggest financial mistakes made in a divorce," cautions Anthes, "especially where one spouse relinquishes rights to the other spouse's retirement plan in trade for the home."

The problem, says Anthes, is that it costs money to make the mortgage payments and maintain the home. This might be easily done with two incomes, but perhaps not with one, particularly if the single homeowner doesn't earn a lot. Meanwhile, the assets in the retirement plan continue to grow tax deferred, often increasing much faster in value than the value of the home. The homeowner sometimes ends up losing the home and also ends up without any retirement benefits.

A better scenario might be to sell the home and split the profits as part of the divorce settlement.

Watch out for debts

Be cautious about debts run up during the marriage, and those run up during the divorce proceedings when emotions are high. Although the court may divvy up the debts between the divorcing parties, the fact remains that creditors can generally go after either party for payment. Debts run up after the divorce are the responsibility of each party acquiring those debts. Use the time before the divorce is final to close out joint credit cards and establish credit with a card under your own name.

Be sure to determine how any current-year and past-year tax bills will be handled before the divorce is finalized. When married couples sign a joint tax return, both are liable for the taxes due. Though you may be divorced now, the fact that your signature is on a joint tax return from two years ago still means the IRS can require you to pay any taxes due, even if your now ex-spouse can't afford to help with the bill. If you feel you signed a joint return without fully understanding how your taxes were prepared, you may be eligible for "innocent spouse relief"; consult a tax advisor for more details.

One other potentially significant future debt obligation may be college. Education costs are rising rapidly, and if young children are involved in a divorce situation, the custodial parent may face some big college bills 10 to 15 years from now. A single parent may spend more on college than on the cost of a home! Consider factoring in a reasonable amount of expense for future college bills, based on the number of children in the family who may attend college. Estimate the future cost of college using an appropriate college-inflation rate (which is usually two to three times the rate of inflation in the overall economy).

Estate planning and titling issues

Divorcing couples typically want to drop each other as beneficiaries of such legal instruments as wills and powers of attorney, but this often is overlooked. Some experts suggest making these changes before the divorce is final, in the event that one of the spouses dies before the divorce proceedings are completed.

Titling issues of jointly held property is another area that requires attention. The majority of couples hold their home, bank accounts and investment accounts in joint tenancy with right of survivorship. In the case of bank accounts and other cash equivalent accounts, such as money markets, it may be best to divide the accounts and establish separate ones.

Homeownership usually can be easily converted to tenants in common, in which each party is considered to own one-half of the home; but you'll want to check on this with an attorney familiar with your state laws.

Another caution: delay any inheritances you're expecting. If you inherit before the divorce is final, the property could end up being counted as part of the marital property and subject to division.

Seek professional help

Divorcing couples will work with attorneys, but Anthes recommends that couples also bring in a financial planner or other financial advisors. "Many attorneys aren't as familiar with the complexities of the financial issues as a financial planner. Valuing a small business, for example, or making an equitable division of stock options, a 401(k) plan, a nonqualified plan and a home requires a great deal of expertise. It's also wise to project future cash flow and expenses for each party, particularly where such issues as child support may be involved, to address any inequities before the settlement is final."

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