Financial Mistakes to Avoid in a Divorce
We have all heard that half of all marriages end in divorce. However, divorce in the U.S. has been on the decline since the 1980s and the current percentage of married couples splitting is roughly 39%. A 2016 study found that younger individuals were 18% less likely to get divorced. Unfortunately, divorce still occurs, and it can be one of the most financially and emotionally devastating events that happens in a lifetime.
To avoid making the situation worse, keep in mind that there are new alimony rules under the Tax Cuts and Jobs Act (TCJA). For instance, before TCJA, a spouse paying alimony would get a tax deduction and the spouse receiving alimony was required to report the income as taxable income. However, for divorces finalized after December 31, 2018, the person paying alimony no longer gets a tax break.
Other Financial Mistakes
In addition to the new TCJA alimony rules, there are other common financial pitfalls that should be avoided in a divorce:
- Retail Therapy - It’s tempting to start spending when going through a divorce. Indulging in an expensive vacation or buying a new house or car won’t help your situation. Avoid retail therapy and try to avoid making any big decisions that will affect your finances. The spending high is short-lived, and you’re left with bills you can no longer afford.
- Pulling Money out of Your 401(k) - Money can be tight during a divorce and your 401(k) might look like a treasure chest that could solve all of your short-term money problems. But, if you don’t have taxes withheld, you could face another huge tax bill, and the IRS will slap on a 10% penalty if you’re under the age of 59 ½. Also, withdrawing all of your cash at once could bump you into a higher tax bracket.
If your divorce settlement includes a qualified domestic relations order (QDRO), meaning that you get a portion of your former spouse’s retirement accounts, put this into an IRA under your own name and continue to defer taxes.
- Cashing in Investments - You may be tempted to sell your investments to cover some of your legal fees. When you sell highly appreciated assets, you typically owe substantial taxes. Additionally, since those assets will no longer be invested, you are derailing your financial and retirement goals. If you do decide to cash out your investments, first ensure that you have enough income to continue your current lifestyle.
- Quitting Your Job to Avoid Paying Alimony – Sometimes in a divorce, the primary breadwinner is so angry they quit their job to avoid paying alimony. Not a smart financial move! This can end up causing more time in court and more attorney fees, while delaying the inevitable. You also risk losing steady income which can far outweigh the alimony payments.
- Fighting Over Who gets the House – Consider all of your options before deciding who gets the house. For instance, evaluate the maintenance costs. If neither spouse can afford the up-keep or the mortgage payments, it doesn’t matter who gets the house. It’s also not uncommon for one person to end up with a house that’s worth less than what they owe (negative equity).
- Lack of a Financial Plan – You might feel like you’re finally free to do whatever you want with your money. However, one of the biggest mistakes you can make is not having a financial plan after a divorce. It’s tempting to start spending money on things that might bring you joy, especially if you’ve been in an unhappy marriage, but the financial mistakes you make right after a divorce can haunt you later. Consider seeking advice from an expert. A trained advisor can help you set up an action plan and provide direction to gain control over your financial affairs.
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Article written by Keith R. Hoffman, CPA, CDFA