Asset Inequality in Divorce
Whether a divorce or legal separation is amicable or not, when splitting up your family’s estate, it is important to remember that not all assets are considered equal. This comes into play especially when a couple is agreeing to divide everything “down the middle.”
As a note: the purpose of this post is not to further complicate what may already be a messy and painful process, but to better equip those in negotiation, whether it is one-on-one, with a mediator, or with an attorney. For many, a divorce or separation can be one of the biggest transitional events ever experienced. And as it pertains to the rise of “grey divorce,” or the continuing trend of older demographics separating from their significant other, the discontinuance of employment (retirement) makes income a leading worry during asset splitting.
Here are 4 considerations that are often overlooked:
The Untouchables
There are several types of assets that are not considered “marital property” when a couple decides to legally separate.
- Assets acquired before marriage
- Assets received as an inheritance to one spouse
- Assets received as a gift to one spouse
- Awards for personal injury
These assets are considered separate property and are not part of the marital property split. It is only by personal choice that these assets can be divided.
Where things get real complicated, real fast…the commingling of assets. If money from separate property is comingled with marital property (think if a joint checking account is used to pay the mortgage on a house acquired before marriage) then a portion of the property is considered separate, and the remaining amount is considered marital.
Taxes
$1 in a checking account is not equal to $1 in a retirement account. Remember, in traditional retirement accounts (Traditional IRA, 401k, 403b, SEP IRA, etc.) income taxes are deferred until a withdrawal is made. And after separation, a person’s new tax bracket can differ greatly.
Using our example, if money is withdrawn from a checking/savings account, the amount is not taxed, but when the person withdraws retirement money, they must pay ordinary income tax on the amount. Thus, a true 50/50 split of assets considers the tax type/consequence of each asset.
Also, it is very important to remember that you can split every type of asset with a legal divorce or separation order EXCEPT certain employer retirement plans (401k or 403b, sometimes government 457b plans). These accounts need a Qualified Domestic Relations Order to be split and must be immediately rolled into an IRA to not incur a 10% penalty (for the non-employee spouse).
Liquidity
On paper, a house’s value and an investment account’s value may be the same, but when it comes down to upkeep and ability to access the value, the two are vastly different. A home is an illiquid investment, meaning the value is not readily accessible, and is dependent on a slower market.
Also, it should be mentioned that some people, when receiving their family home in the divorce settlement, do not realize that they no longer have the means of maintaining the home (mortgage, insurance, taxes, and upkeep) after the divorce. These types of what-if situations must be played out before the final asset split is decided.
State Law
There are 9 states which are considered “Community Property” states.
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In Community Property states, the courts consider assets that are acquired during marriage 50/50 ownership. This means that if you are not able to come to an agreement on how assets are split, it is an automatic 50/50 regardless of a person’s financial position.
In all remaining states, if you are not able to come to an agreement, the courts can split assets equitably (fairly) and not necessarily 50/50. They can consider each individual’s financial position when deciding on the split.
Divorce or legal separation can be a very messy and painful process, and extra asset considerations can create even more confusion around the simplest estates. While it is always good to work with a mediator or divorce attorney, a financial planner can be of immense help in determining optimal asset splitting, and how that split could impact your life beyond your first year of separation. Ambient helps you address each asset individually so that you can make the best decision.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.