I have found that in many cases a divorcing couple becomes focused upon the division of assets without consideration to the cost of ownership and income tax issues, which can create a significant imbalance.
Before you sign a Property Settlement Agreement (PSA), be sure that you truly understand the financial implications it will have upon you both in the near term and especially for your long term financial wellness. In addition, the division of the property may have effects upon the amount of spousal and child support being paid.
Let me give you an example and then I will outline a few items that can make a big difference in the negotiation process.
The couple has accumulated $250,000 in a joint investment portfolio, $500,000 in retirement accounts and has about $450,000 of equity in their house, all considered marital. Ignoring other assets for this illustration, the simple thing to do would be to sell the house and divide all of the assets equally.
However, doing this could create an imbalance due to the joint portfolio unless each position in the portfolio were equally divided. That is because certain holdings in the portfolio may have capital gains while others may have capital losses. Let’s say the husband offers to retain the XYZ fund valued at $125,000 and suggests that wife retain the ABC fund with the same value.
However, upon further analysis it is determined that the cost basis for the XYZ fund is $150,000 and the cost basis for the ABC fund is $50,000. The accounts are not equal! The XYZ fund has $25,000 of capital losses while the ABC fund has $75,000 of capital gain, a huge difference! The losses are tax deductions while the capital gains are taxable income!
Alternatively, the wife says she wants to retain the house and is willing to allow the husband to keep all of the retirement assets in return. Would you take that deal? From a pure monetary position it would appear that she gets $450,000 of equity and gives up $500,000 of assets.
There are two issues to consider in this trade off; the first is that the house has a significant carrying cost for the mortgage, taxes, insurance and maintenance while the retirement account has no cost to own. Secondly the equity in the house may be partially taxable if overall appreciation is more than $250,000 and the excess would be subject to capital gains while the retirement plan will grow tax free (deferred) until withdrawn at ordinary tax rates.
Now, which deal would you rather take: the house or the retirement plan?
There are other considerations but the point is that unless all assets are divided equally, it is imperative to understand the cost of ownership (cash flow) and the real net after tax value before making a decision on the division of property in a divorce settlement.
Unfortunately, what often happens is that the lawyers are negotiating on your behalf and ask you if the division of property is okay with you once they have reached a tentative agreement. In most cases, your ability to make clear decisions is impaired due to the emotional stress and strain of the divorce process.
As a result, a year or two later you wake up and realize that you really did not understand the consequences of your decisions but cannot go back and make changes.
My suggestion is to form a team of legal, mental health and financial professionals to assist you during the divorce process, regardless of the divorce methodology chosen – another topic for a future article!
Do you understand the legal issues related to a Property Settlement Agreement? Did you have a team of professionals help with your divorce? What kind of bargain seems fair to you in your circumstances today? Please share your experience and advice in the comments.
Editor’s note: This article is not intended to provide legal or financial advice. Please consult your financial professional regarding your situation.
Tags Divorce After 60