Divorce is a time of unprecedented change. It’s also the biggest financial event of your life.
The simple fact is you don’t know what you don’t know. That’s why it’s so important to get educated so you can make smart financial decisions before, during, and after divorce.
In this guide, I break down the 101 financial pitfalls of divorce.
You see, once you know about the landmines, you can take steps to avoid them. Knowledge is power!
You don’t have to do it on your own. There are tons of great resources and divorce professionals that can help you navigate this difficult transition.
With that, let’s dive in.
- Top 10 Financial Pitfalls of Divorce
- Divorce Process and Preparation Pitfalls
- Divorce Negotiation Pitfalls
- Divorce Professional Pitfalls
- Divorce Financial Planning Pitfalls
- Home and Mortgage Pitfalls
- Debt and Credit Pitfalls
- Divorce Tax Pitfalls
- Alimony and Child Support Pitfalls
- Budgeting and Cash Flow Pitfalls
- Pension and Retirement Pitfalls
- Stock Option and RSU Pitfalls
- Life Insurance and Annuity Pitfalls
- Kids and Education Funding Pitfalls
- Even More Financial Pitfalls of Divorce
Top 10 Financial Pitfalls of Divorce
First, here’s an infographic highlighting the top 10 financial pitfalls of divorce.
Here’s my take on the top 10 financial pitfalls from the infographic:
1. Relying on advice from your friends and family.
Your friends and family have good intentions. They want to support you through this difficult process.
Unfortunately, their advice is almost surely misguided. Do they know the divorce laws in your state? Do they know the totality of your financial situation (breakdown of your assets, how much you make, how much you spend)? Then how can they possibly give you good advice?
It’s perfectly fine to use your family and friends for emotional support and to vent. Just steer clear of their advice on what you’re “entitled” to or what you should do.
2. Not keeping records.
The first rule of divorce is: document, document, document.
What’s the second rule?
That’s right, you guessed it: document, document, document.
It’s absolutely critical that you maintain good records for a myriad of reasons. Most importantly, your divorce team (attorney, divorce financial planner) needs reliable information in order to advise you and protect your interests.
3. Not coming to grips with your financial reality.
There’s a lot of talk about maintaining your lifestyle after divorce. In some states, maintaining the marital standard of living is one of the stated goals of spousal support.
Here’s the problem… in the vast majority of cases, that’s simply not possible.
Your expenses go up because now there are two households to support.
Don’t focus on maintaining your lifestyle at the expense of your financial security.
4. Keeping a house that you can’t afford.
Deciding what to do with the house can be an emotional decision. Many people see their house as a source of stability – both for their kids and themselves.
Be careful not to overextend yourself.
Start by making a list of all your housing expenses – mortgage payments, property taxes, homeowner’s insurance, utilities, and maintenance costs – to make sure you can afford to keep the house.
5. Jumping to the negotiation phase too soon.
You can’t begin negotiating until you have clearly defined goals and priorities and a full understanding of the financial picture.
Start by gathering and organizing your financial information. You should have a comprehensive marital balance sheet, budget, and income summary before you start negotiating.
Negotiating too soon almost always backfires. Chances are either you or your spouse will want to back out of any unwritten agreements once you get more information. When that happens, the other party begins to question whether you can keep your commitments.
6. Not evaluating settlement proposals from a financial perspective.
There are two perspectives to evaluating a settlement proposal. 1) What am I entitled to legally? 2) What does this mean for me financially?
Most divorcing individuals make the mistake of focusing exclusively on the former. Your divorce attorney can help you with this piece. If you’re looking at the big picture, the latter is actually just as important. This is what I like to call the “Can I Settle” analysis. You’ll feel much more comfortable saying “yes” if you know you’ll be okay financially.
7. Relying on Zillow to value the house.
Check the estimated values on a few of these online real estate sites, and you’ll see just how much they differ. You see, Zillow and these other sites use a computer algorithm to estimate the value of your house. One of the major problems is that Zillow often has inaccurate information on the characteristics of your property and the comparable properties – square feet, condition, etc. This can lead to wildly inaccurate values in some cases.
If you want a more reliable determination of how much your house is worth, hire a real estate appraiser or have an experienced realtor prepare a comparative market analysis (CMA).
If you go with a realtor, just be sure to let them know that you’re looking for a realistic valuation so you can determine what to do with the house in your divorce. Realtors are notorious for giving a high value to “get the listing.”
8. Not considering tax implications.
This is a big one. In fact, there could an entire guide dedicated to this topic.
The general rule is that any transfers between spouses or former spouses related to divorce are tax-free. The IRS lays out the requirements for a transfer to be considered incident to divorce.
You might be thinking, “if the transfers are tax-free, then why do I need to worry about taxes?”
Fair question. Let’s look at a couple examples.
Let’s say you paid $200k for your house, it’s worth $1M, and there’s no mortgage. You decide to buy out your spouse for $500k (1/2 the equity).
A year later you decide that you can’t afford the house and put it on the market. To keep things simple, let’s assume that it sells for $1M and ignore any realtor commissions or other selling expenses. Let’s also assume that you qualify for the $250k exclusion on the sale of a primary residence under IRC section 121.
Okay, so your taxable gain is $550k ($1M sale price minus $200k purchase price minus $250k exclusion). If we assume your capital gains tax rate is 15%, then the tax hit is $82,500.
If you had sold the house jointly, the exclusion would be $500k which would reduce the taxable gain to $300k. That brings the tax hit down to $45k which would be split 50/50. So, your share of the taxes under this scenario are $22,500. That’s a $60,000 difference ($82,500 minus $22,500).
As another example, let’s say your spouse proposes that he keeps the house worth $500k and you keep the 401k worth $500k.
Fair trade? Not so fast…
What happens when you take distributions from the 401k? Those distributions are taxed as ordinary income. If we assume you’re in the 30% tax bracket, that means you’re getting 70 cents on the dollar.
It’s not what you get that matters, it’s what you keep.
Keep in mind – we’ve really just scratched the surface here. Some of the tax rules get complicated which is why I recommend working with a financial professional that understands the nuances of divorce taxation.
9. Not requiring your spouse to remove your name from the mortgage.
If you’re on the mortgage, then your credit is at risk.
In the lender’s eyes, it doesn’t matter that the settlement agreement says that your spouse is solely responsible for the mortgage. If your spouse misses payments, you’re on the hook and your credit could take a serious hit.
There are only two ways to be removed from a mortgage: 1) the loan is paid off, 2) your spouse removes your name from the joint mortgage by refinancing (or assuming the loan, if permitted).
Pro tip: Don’t take the banker’s word for it that your mortgage is assumable. Check the terms of your promissory note and get something in writing from the bank that spells out the stipulations of assuming the mortgage. I’ve seen this fall through far too many times.
10. Not considering the cost/benefit analysis of your decisions.
The smart money folds. It’s one of my favorite sayings of divorce negotiation.
To be clear, I’m not saying that you should roll over and accept whatever your spouse proposes as a “fair” settlement. But you do need to weigh the costs involved.
Don’t make emotional decisions or try to use your divorce to punish your spouse for their wrongdoings. Trust me, you’ll end up punishing your bank account in the process.
Work with an attorney that can give you a good understanding of the likelihood of the possible outcomes if you go to court and the anticipated cost of litigating those issues. Be sure to factor in the emotional toll that litigation can take on your mental health and your family (particularly if you have kids). Then work with a Certified Divorce Financial Analyst that can help you understand what all of this means for you financially.
Only once you have a good grasp of the cost/benefit analysis, can you make an informed decision on how to proceed.
Divorce Process and Preparation Pitfalls
11. Not doing a thorough job completing your financial disclosures (affidavits).
Good decisions begin with good information.
In all states, you’re required you to complete financial affidavits as part of the divorce process. You need to list everything you own and everything you owe, what you make and what you spend.
I won’t lie to you… It’s time-consuming and, frankly, not much fun. That’s why so many people rush through these important documents.
The result: making BIG decisions with major blind spots.
Put in the time to gather all of the supporting financial documents and be thorough when completing your financial disclosures. It will save you time in the end and prevent costly financial mistakes. Not to mention you’re signing the financial affidavits under penalty of perjury.
12. Not doing your homework on how the divorce process works.
There’s a ton of great information and resources out there. You owe it to yourself to get educated about the divorce process. There are enough unknowns during divorce as it is – having an understanding of the process will reduce your anxiety.
13. Not considering your divorce options.
There are alternatives to battling it out in court. The choice you make for how you get divorced is the most important decision you’ll make.
Take the time to understand your options. Mediation or collaborative divorce can be great options for resolving disputes in a less adversarial manner.
14. Not developing a financial organization system.
There’s gobs and gobs of paperwork as part of the divorce process. You need to stay organized and keep good records.
Lucky for you, we put together a Financial Organization Guide to make things easy for you.
15. Attempting to use your divorce to punish your spouse and get justice.
You need to think about your divorce as a business transaction. I know it sounds cold, but it’s the best advice I can give.
From a financial perspective, divorce is the unwinding of an economic partnership.
Divorce court is simply not the place to get revenge for your husband or wife’s wrongdoings. You’ll end up punishing yourself and your kids in the process.
16. Assuming that your spouse won’t be amenable to mediation or collaborative divorce.
After the decision to divorce, the most important decision is how you get divorced.
Divorce doesn’t have to be a war. Don’t assume your spouse isn’t willing to go another route.
As hard as it may be, do your best to sit down with your spouse and determine what type of divorce is right for you.
If you’re not able to have this conversation one-on-one, then make an appointment with a neutral financial specialist or mediator so they can explain your options.
17. Failing to fully disclose your assets, debts, income and expenses.
A lack of disclosure can come back to bite you in more ways than one.
First, the lack of transparency will further erode whatever trust remains and likely lead to extensive discovery. You can expect monster attorney bills once significant discovery gets underway.
To make matters worse, any omitted assets could be awarded in their entirety to your spouse. There was a famous California case where the wife won $1.3M in the lottery about a month before filing for divorce. She never disclosed the lottery winnings. The husband found out about the money after the divorce was done. The court ended up awarding 100% of the lottery winnings to the husband. Ouch!
18. Not communicating with your spouse about financial decisions.
If you’re getting divorced, I’m willing to bet that communication has not been great for a while.
As hard as it is to talk with your soon-to-be ex-spouse, communication is critical during this transition. It’s perfectly fine to keep the communication business-like.
If you don’t communicate, your spouse will assume that anything you do is done with bad intentions (even if there’s a good reason behind it).
Always communicate any big financial moves ahead of time – even if they’re just part of the normal day-to-day activities (such as paying your taxes).
19. Not accepting the divorce.
If you don’t want the divorce, that makes the whole process that much more difficult.
It takes time to process the end of your marriage, and it’s completely normal to feel like you’re on an emotional rollercoaster.
On the financial side, try to look at the divorce as a business transaction. I won’t sugarcoat it. This is easier said than done. But you really need to try to compartmentalize things. Otherwise, you risk making emotional decisions that set you back financially.
Divorce Negotiation Pitfalls
20. Not thinking creatively.
Once you have a good sense of your goals and priorities, you can begin to brainstorm settlement ideas. This is your chance to get creative.
Want to keep the house but your cash flow is a little tight? Perhaps you can rent a room on AirBnB to increase your income or reposition your investments to generate more interest and dividend income.
21. Taking your spouse’s word for it.
Trust but verify. Words to live by during divorce.
Get supporting documentation to back up any of your spouse’s claims (account balances, separate property, etc.).
22. Rushing to finalize your divorce.
Remember, it’s a process. Divorce is likely the single biggest financial event of your life. You want to take your time to make informed decisions.
23. Not doing your homework.
One of the downsides to mediation and collaborative divorce is no one has the authority to force you to do anything.
If you show up to mediation sessions without doing your homework, your spouse is sure to get frustrated. It’s a waste of time and money. If you don’t do your homework a few times, your spouse may have no choice but to take you to court to move things forward.
Be realistic about how much you’re able to get done and set realistic timelines.
24. Not keeping your commitments.
Keeping your commitments is of the utmost importance if your goal is to reach a resolution without going to court.
If you back out of your commitments, your spouse will begin to question whether you’re negotiating in good faith. It doesn’t take long for that to have a snowball effect.
Don’t commit to any agreements unless you believe you can stick to them. It’s perfectly acceptable to say that something sounds like it may work for you, but you need to speak with your attorney before agreeing to anything.
25. Not thinking about the big picture.
I once had a client tell me that her husband went through their spice cabinet and took ½ of all the spices!
Talk about losing sight of the forest for the trees!
You want to be detailed about gathering financial records so you have accurate, thorough information. But don’t get bogged down with trying to track every single penny or put a value on all your belongings. This will just give you and your spouse more things to fight about.
Stay focused on the big picture and what’s truly important to you (financially, emotionally, kids).
Divorce Professional Pitfalls
26. Not working with a Certified Divorce Financial Analyst (CDFA).
If you have a short-term marriage with minimal assets, then you probably don’t need a Certified Divorce Financial Analyst.
But, if you have any degree of financial complexity to your divorce, chances are you can benefit from working with a CDFA.
An experienced CDFA can help you steer clear of all the financial mistakes covered here by making sure you understand the short and long-term financial and tax implications of your options.
If you’re interested in learning more about how a CDFA can help, check out our guide: What is a Certified Divorce Financial Analyst?
27. Sending short, frequent emails to your lawyer and other divorce professionals.
Divorce is overwhelming and scary. It’s a totally foreign process. You’re bound to have questions and thoughts pop into your head throughout the day.
It can be tempting to fire off a quick email to your attorney and advisors whenever this happens.
Try keeping a running list of these things. Consolidating your questions will keep costs down.
It takes me far less time to respond to one consolidated email with ten questions than ten scattered emails. Less time equals lower costs!
28. Not trusting your divorce team.
If you don’t trust you divorce attorney and other advisors, find new ones. You need to have advisors that you trust. Otherwise, you’ll drive yourself crazy and drive up your costs by waffling back and forth on your decisions.
Do your due diligence up front so you feel confident in their advice and guidance.
This video will help you understand the key professionals you may need when building your divorce team:
29. Not getting professional help.
Whatever you do, don’t try to do it all yourself. Now is not the time to be pennywise and pound foolish. You need all the help you can get right now. And
There are three dynamics involved during divorce – financial, legal, and emotional. So get professional help in these areas. Work with a Certified Divorce Financial Analyst to help you make smart financial decisions. Talk to a therapist to get the emotional support you need. And hire a good attorney.
30. Not working with a divorce mortgage advisor.
Are you planning to keep the house and buy out your spouse? Or considering purchasing a house after divorce? That’s where divorce mortgage planning comes in.
Don’t make the mistake of treating the mortgage as an afterthought.
A divorce mortgage advisor can help you evaluate how much alimony or child support you need (or can afford to pay) in order to qualify for a mortgage.
31. Hiring the cheapest divorce lawyer.
It can be tempting to look for a divorce attorney with the lowest hourly rate.
My advice: Don’t!
If you hire the cheapest divorce attorney in the area, chances are you won’t feel confident in their advice. Divorce is complicated enough – you don’t want to find yourself second-guessing your lawyer at every turn. Hire an experienced attorney that you can trust.
32. Relying on your divorce attorney to take care of “everything.”
The first problem with relying on your lawyer too much is that attorneys are expensive.
Resist the temptation to use your lawyer as a therapist.
Your attorney has a lot on their plate. They probably have a full caseload and sometimes things fall through the cracks. You need to be an active participant to ensure the best outcome.
Divorce Financial Planning Pitfalls
33. Not taking a long-term view of your finances.
I get it…
It’s hard to plan ahead when it feels like the sky is falling. Or as Mike Tyson famously said, “everyone has a plan until they get punched in the mouth.”
But the reality is divorce is likely the single biggest financial event of your life. You can’t afford to think short-term. Your financial future is at stake.
This is where a Certified Divorce Financial Analyst comes in. A CDFA can help you understand the long-term financial implications so you don’t make costly mistakes – like keeping a house you can’t afford.
If you have any semblance of financial complexity, I strongly suggest doing a basic cash flow analysis.
34. Not getting educated on your financial situation and preparing for financial independence.
Be sure you understand ALL the terms of your divorce settlement. You need to be empowered to take control of your financial affairs. This starts with getting educated.
35. Not updating your estate planning documents (wills, trusts, medical directives, powers of attorney) after divorce.
Now that your divorce is finished, it’s time to turn your attention to another fun topic… death!
All jokes aside, it’s critical to update your estate plan so it reflects your post-divorce objectives.
It’s easy to put this off. Don’t!
Do you want your ex-spouse to be making decisions about whether to pull the plug? Then you had better update your advance medical directives. Also, update your will and trust so your assets go to your intended beneficiaries.
36. Not updating your beneficiary designations (retirement plans, life insurance, etc.) after divorce.
This goes hand-in-hand with updating your estate planning documents. Once the divorce is finalized, you need to update your beneficiary designations on retirement accounts and life insurance policies.
Home and Mortgage Divorce Pitfalls
37. Not evaluating whether you can qualify to refinance the mortgage.
If you’re keeping the house, your spouse will likely require you to refinance to remove their name from the joint mortgage. You need to know whether you qualify to refinance before signing an agreement.
Work with a divorce mortgage specialist early in the process to conduct a feasibility analysis and assess how the mortgage fits into your settlement strategy.
38. Not considering deferred maintenance on the house.
Is your house due for a new roof? Perhaps you’ve put off making other necessary repairs for the last few years. If so, make sure to factor these future expenses into the cost of keeping the house.
39. Not properly evaluating the rent vs. own decision.
I can’t tell you how many times I’ve heard, “but my mortgage payment is less than it would cost to rent” to justify a desire to keep the house.
The problem is you’re comparing apples and oranges.
What about property taxes, homeowner’s insurance, and maintenance? Those costs can add up. You also need to consider the potential investment income you could earn if you invested your share of the equity.
That’s not to say it’s necessarily a bad decision to keep the house. You just need to be sure you’re doing an apples-to-apples comparison.
40. Not confirming that there are no liens or clouds on title.
In plain English, a cloud on title is basically any issue that creates uncertainty about whether the title is clean.
Clouds on title make it difficult to transfer ownership from one party to another because the purchasing party doesn’t know what they’re getting. Some examples of clouds on title include any claim, unreleased lien or encumbrance that might make the title doubtful.
How do you find out if there are any liens or clouds on title?
The easiest way is to ask your divorce mortgage specialist or realtor to obtain a title report and walk through it with you.
41. Not understanding that spousal support and child support require 6-month history of receipt and 3 years of continuance to be considered as ‘qualified income’ for mortgage purposes.
One of the key criteria that lenders look at when determining if you’re a qualified borrower is your debt-to-income ratio. The lower the better. For instance, you might need a debt-to-income ratio no greater than 45% to qualify for a mortgage.
Here’s the good news…
Spousal maintenance and child support can be used as income to help you qualify for a mortgage.
But there’s a catch…
The mortgage lender wants to know that this is a reliable source of income that will continue. In order to be considered as ‘qualified income,’ you need to document a 6-month history of receipt and 3 years of continuance.
42. Not considering a cash-out refinance as a source of funds to buy out your spouse, consolidate other debt, or pay attorney’s fees.
A cash-out refinance is when you take out a new loan with a higher balance than your existing loan. The funds from your new loan are used to pay off the existing mortgage balance, pay any closing costs, and you get any additional funds. You’re essentially pulling cash out of the equity in your home.
You can use the cash-out refi proceeds for any number of purposes. A few of the more common are to buy out your spouse, consolidate high-interest credit card debt, or pay attorney’s fees.
43. Not realizing that you can get a lower interest rate on a cash-out refinance if it’s part of your divorce settlement.
A rate-and-term refinance involves refinancing the existing mortgage to obtain a different interest rate, term, or loan product without pulling any cash out.
Lucky for you… you can get the lower rate-and-term rates on a cash-out refinance if the refi is included in the divorce settlement and the cash is paid directly to your spouse through escrow. Rate-and-term interest rates are generally 0.125% to 0.25% percent lower than cash out rates.
44. Thinking that coming off title to the house is the same as coming off the mortgage.
The deed to the house and the mortgage are two totally different things.
You can remove a spouse from the deed to the house by completing an interspousal transfer deed or quitclaim deed.
Removing a spouse from the mortgage requires more than just paperwork. It generally requires refinancing the mortgage in your name alone. In some instances, you may be able to assume the loan – but, in my experience, that rarely works.
45. Not thinking through all facets of a co-ownership agreement if you’re continuing to own the house jointly after divorce.
If you’re going to co-own the house with your ex-spouse after divorce, there are a number of issues that need to be clearly defined.
Here are a handful of issues to consider:
- Who is responsible for paying the mortgage, property taxes, and homeowner’s insurance? What happens if that party fails to make the payments?
- What are the “triggering” events that would cause the property to be sold?
- How are repairs and maintenance handled? How are improvements handled?
- What happens if one spouse wants to sell and the other doesn’t? Does the spouse that wants to keep the house of Right of First Refusal (the right to buy out the other spouse)?
It’s worthwhile to take the time to discuss these issues to prevent misunderstandings down the road.
46. Not considering potential rental income from your primary residence.
Can you generate some extra income by renting out a room on Airbnb? It’s worth looking into if cashflow is tight and your priority is keeping the house.
One of my clients with young kids did this. She was (understandably) concerned about bringing strangers into the house. But guess what…the kids loved it and thought they were running a bed and breakfast!
Debt and Credit Divorce Pitfalls
47. Failing to close joint credit cards and other joint debt (HELOCS, etc.)
Bottom line: If your name is on the debt, your credit is at risk. It doesn’t matter if your divorce decree says otherwise.
Your divorce decree is a contract between you and your spouse. The lender is not a party to the agreement, so it is not bound by the terms of your agreement.
That’s why it’s always a good idea to close any joint credit cards or other joint debt.
48. Not pulling a credit report before AND after divorce.
Pulling a credit report is the best way to identify any joint debts or debt in your name.
You want to be sure to close any joint accounts. It’s not enough for the divorce decree to assign a joint account to your spouse. Keep in mind that lenders or credit card companies are not bound by the terms of divorce agreements. In other words, if your name is on the debt, you’re still liable!
49. Not building your credit during and after divorce.
Get a credit card in your name. Start by applying for a card with a low credit limit and make all payments on time.
If you’re starting from ground zero, there’s a few options for you to consider. You can get a secured credit card or credit-builder loan, or you can become an authorized user on a family member’s card. Just remember that it takes time to build your credit. That’s why it’s so important to get started!
Divorce Tax Pitfalls
50. Not considering the dependent tax exemption.
Under the Tax Cuts and Jobs Act (TCJA), the dependent exemption has $0 value. But that doesn’t mean it doesn’t matter.
First, many provisions in the TCJA are set to sunset (expire) after 2025. This means that there is a potential future value to the dependent exemption.
Also, your ability to take/maximize other tax credits – such as the child tax credit and earned income tax credit – flow with the dependent exemption.
51. Not realizing that tax filing status is based on your marital status on the last day of the tax year.
It doesn’t matter if you were married for 364 days of the year. If your divorce is finalized on December 31st, then you’re considered unmarried for tax purposes.
If you’re unmarried, your tax filing status options are single or head of household.
If you’re married, your tax filing status options are married filing jointly, married filing separately, or possibly head of household (more on this below)
52. Not realizing that the Head of Household tax filing status cannot be traded.
Unlike the dependent exemption, head of household cannot be released or “traded.”
To file as head of household, you must meet the IRS requirements.
- Pay for more than half of the household expenses
- Be unmarried
- Have a qualifying child or dependent. Generally, this means your child must have lived with you for more than half the year
53. Not realizing that you may qualify to file as head of household even if you’re still married.
I know what you’re thinking… Didn’t you just say you must be unmarried to file as head of household?
Well, if you did not live with your spouse at any time during the last 6 months of the year (and you meet the other requirements), then you’re eligible to file as head of household. I call this the 6-month rule.
The major benefits of head of household vs. single is you get a larger standard deduction ($18,350 vs $12,200) and you can earn more money before moving into a higher tax bracket.
54. Not realizing that the tax treatment of alimony has changed.
The Tax Cuts and Jobs Act (TCJA) made sweeping tax changes. Previously, alimony was deductible by the support payor and taxable to the recipient. Now, alimony is nontaxable (for new agreements executed after 12/31/18).
Keep in mind that not all states have conformed to the Federal tax changes. For instance, in California, spousal support is still taxable to the recipient and deductible by the payor on State returns.
Alimony and Child Support Pitfalls
55. Not considering personal expenses paid through the business if your spouse is self-employed.
If your spouse is self-employed, that presents a whole lot more complexity. To a certain extent, your spouse has control over their income. It’s not as easy as looking over their W-2 to figure out their earnings.
It’s common for business owners to run personal expenses through the business to reduce their taxes. In divorce negotiations, you need to determine if any personal expenses are paid through the business. Those personal expenses may need to be added back to your spouse’s income as nontaxable income.
56. Not understanding the full extent of your spouse’s compensation package.
If you’ve been kept in the dark about your finances, now is the time to get up to speed. Divorce may not be the best time for a crash course in personal finance, but it’s certainly the most important.
You need to know if your spouse participates in a deferred compensation plan or Employee Stock Purchase Plan (ESPP). Does your spouse contribute to a 401(k) plan or receive stock options and Restricted Stock Units (RSUs)?
Just reviewing the tax returns isn’t good enough. Get a copy of your spouse’s W-2’s and year-end pay stubs for the last few years. That will give you a breakdown of their compensation. In the W-2 below, you can see the RSU income and 401k contributions.
If necessary, you can subpoena the company to get additional details about your spouse’s compensation package.
Budgeting and Cash Flow Divorce Pitfalls
57. Not maintaining enough cash reserves.
To paraphrase the great Warren Buffett: Cash is like oxygen. When you have enough, you don’t give it a thought. But when you’re running out, you can’t think about anything else.
The last thing you need right now is a cash shortage. Make sure you have enough cash on hand as part of the settlement agreement.
58. Not preparing a post-divorce budget.
Look, I get it. Budgeting probably isn’t at the top of your bucket list.
While preparing a budget might not be fun, it’s absolutely critical. After all, you need a solid understanding of your expenses in order to evaluate the financial implications of settlement proposals.
59. Not evaluating your cash flow.
This goes hand-in-hand- with preparing a post-divorce budget and not having enough cash reserves (emergency savings). You need to understand your income, taxes, and expenses in order to determine your liquidity needs.
60. Not planning for the cost of divorce.
Let’s face it. Divorce can be expensive. Start squirreling away money if you think a divorce may be looming.
61. Not creating an interim (temporary) cash flow agreement with your spouse for during the divorce process.
There are two primary options for handling cash flow during the divorce process. The first option is to separate finances and enter into a temporary support agreement where one spouse pays alimony and child support to the other spouse.
The second option is called “pooling and sharing.” With this option, you and your spouse continue to pool your income and share expenses.
If you’re in litigation, chances are you will enter into a temporary support agreement and separate your finances. But if you’re trying to reach an agreement out of court, then you’ll need to come up with a short-term agreement for managing your cash flow.
62. Not considering one-time expenses.
Ignoring one-time expenses is a classic budgeting mistake. But the margin for error is smaller during divorce. Make a list of any one-time expenses. Some examples include braces, laptop, deferred maintenance on the house, moving expenses, or furnishing a new home. You need to make sure you have enough cash on hand to cover these one-time expenses.
63. Not breaking your budget into categories.
It’s not enough to simply get a sense of the cost of your lifestyle.
You need to drill down further.
What are your “must-have” expenses vs. your “nice-to-have” expenses.
Does your budget include non-recurring (one-time) expenses that should be backed out?
What are the housing expenses? How much are the child-related expenses?
Trust me, breaking your budget into categories will be especially helpful when it comes time to evaluate any settlement proposals.
64. Not considering the stability of your job and your spouse’s job.
Divorce can be a full-time job, especially if you find yourself in high-conflict litigation. Responding to discovery requests (request for production of documents, interrogatories, depositions), trips to the courthouse, meetings with your attorney, and the list goes on.
It’s hard to stay focused when everything in your life is in flux.
I’ve seen it time and time again. High powered executives lose their job during divorce because they’re no longer performing at pre-divorce levels.
65. Relying too heavily on your bonuses or your spouse’s bonus income.
Make every effort to plan your budget on your base salary and base spousal and child support. This way you can use your bonuses or bonus support (on your spouse’s bonus income) to save for retirement and any luxuries that didn’t fit in your budget.
If you’re counting on your bonuses to make ends meet, you’ll be in hot water if the economy slows down and bonuses begin to disappear.
66. Not considering the cost of childcare.
Childcare costs can be expensive. If you’ve been a stay-at-home mom or dad, then you may not have needed childcare. Be sure to keep this cost in mind when you’re preparing your budget if you’re planning to re-enter the workforce.
On the flip side, there’s another big mistake that I see clients make all the time surrounding childcare.
Here’s the situation…
Let’s say you’ve been home raising the kids and haven’t worked (not to say that raising kids isn’t work!) for many years. If you’re starting back at the bottom of the career ladder, it’s quite common for childcare costs to eat away at all of your earnings. To make matters worse, your earnings could reduce your alimony and child support.
So, why work if you’re not in any better shape financially?
Your cash flow may not improve in the short-term, but you’re positioning yourself to gain valuable experience so you can command a higher income in future years.
Pension and Retirement Divorce Pitfalls
67. Not understanding the true value of pensions.
With a pension, you receive monthly payments upon retirement until you die. You need to determine how much that future stream of payments is worth.
The value of your pension is NOT equal to the balance listed on your annual benefit summary.
Don’t believe me? Take a look at the CalPERS account summary below.
The account balance is $167k…but the pension is worth $1.3M based on an actuarial valuation.
I would strongly suggest working with an actuary or CDFA to calculate the present value of the pension payments.
68. Not considering whether your spouse’s 401(k) plan has a Roth portion.
“I keep my retirement, you keep yours.”
That might be fine if the (marital) values of your retirement accounts are roughly equal.
But you need to dig a little bit deeper. Check the account statements to see if your spouse’s 401k has a Roth portion. Distributions from a Roth 401k are tax-free, whereas distributions from a 401k are taxable.
69. Not getting a Qualified Domestic Relations Order (QDRO) approved by the plan administrator prior to finalizing your divorce agreement.
A Qualified Domestic Relations Order (QDRO) is the instrument (document) that enables you to divide a qualified retirement plan (such as a 401k) without any taxes.
The plan administrator needs to review and approve the QDRO. It’s always a good idea to send a draft QDRO to the plan administrator for their approval. Once approved, then you and your spouse can sign the QDRO and file it with the court.
70. Not considering a 72(t)(2)(C) distribution to access retirement funds and avoid early withdrawal penalties.
There’s not a lot of perks to divorce….but this one of them.
If you’re running low on cash, this tax rule gives you a one-time shot to pull cash from your spouse’s retirement plans and avoid the 10% early withdrawal penalty. (Some states have their own early withdrawal penalties as well. For instance, it’s 2.5% in California.)
Here’s how it works.
Let’s say that you’re receiving 50% of your spouse’s 401k plan which has a total balance of $500k. The 401k would be divided with a Qualified Domestic Relations Order (QDRO). As the non-participant spouse, you can take a withdrawal from your spouse’s 401k plan without penalty. That withdrawal would be taxable income to you, but you would not be subject to any penalties. This is a one-time shot. Once you roll over the funds to an IRA in your name, then you can no longer take advantage of this strategy.
Stock Option and RSU Divorce Pitfalls
71. Not understanding the true value of stock options.
Okay, I’m going to get a little bit technical here. The Black Scholes formula is a model used to calculate the theoretical value of stock options based on a myriad of factors (current stock price, strike price, time to expiration, expected volatility, etc.).
You don’t need to understand all the nuances underlying the formula. The important thing to understand is that there are two components to the value of a stock option: 1) in-the-money value and 2) time value.
In-the-money value is the difference between the current stock price and the strike price of the option (what you would have to pay to exercise the option).
In-the-money value understates the value of stock options. Why? Because it doesn’t consider the time value of stock options.
The easiest way to understand the concept of time value is with a simple example.
Let’s say that you have an option with a strike price of $10 and 2 years until expiration, and the current stock price is $10. The in-the-money value is $0 ($10 minus $10).
Does that mean the stock options are worthless? Of course not.
If the stock price goes down, then you wouldn’t exercise the option so it would expire with no value. But, if the stock price goes up, then you can exercise the option and reap a profit. That’s time value.
I can’t tell you how many times the employee spouse has tried making the case that he/she should get to keep all the stock options at $0 value because they’re underwater. Time and time again I’ve tried to “buy” the stock options from them for $0. Not one has accepted my offer!
72. Thinking that RSUs and stock options that vest after divorce are separate property.
If you or your spouse receive stock options or RSUs, then you need to know whether they’re community (marital) property or separate property.
Many states use a time rule formula to determine the marital interest that’s based on California case law – the Nelson case and the Harrison case.
I won’t get into the nitty-gritty details of the Nelson formula here…but you should know that if a stock option or RSU award was granted during marriage and vests after the date of separation, then there’s likely a community (marital) interest.
73. Not realizing that the taxable income and tax withholdings on stock options and RSUs can be allocated between former spouses.
The general rule is that community (marital) income can be allocated between spouses or former spouses.
That rule applies to the community portion of stock options and RSUs. Let’s look at an example…
Let’s say that you have RSUs vesting this year which generate $10,000 taxable income that are 25% community property and 75% your spouse’s separate property. That means there’s $2,500 community income which could be allocated 50/50 on your tax returns.
Here’s how you would report the RSU income:
You would take the same approach for the Federal and State tax withholding.
By doing this, you and your spouse are each responsible for paying your fair share of taxes on your portion of the income. Fair warning: tracking the allocation can be difficult if you don’t create a tracker spreadsheet from the get-go.
Life Insurance & Annuity Pitfalls
74. Not considering the cash value of life insurance policies.
It’s easy to overlook life insurance as an asset to be divided. In most cases, term life insurance is not an asset to be divided. (It’s still important to consider as it might be used to secure against the possible loss of spousal and/or child support if the support payor dies.)
Permanent life insurance (whole life, universal life, variable universal life, etc.) is a different story. Permanent life insurance often has a cash value component that needs to be taken into consideration as you’re dividing assets. Also, be sure to check for any surrender charges.
75. Not reevaluating your life insurance needs in light of your changing objectives.
Chances are your life insurance needs have changed as a result of your divorce.
Now is a perfect time to take a good hard look at your existing policies to see if they’re still appropriate and cost-effective.
76. Not considering a 1035 exchange for life insurance and annuities.
A 1035 exchange allows you to exchange a life insurance policy or annuity for a new one without having to pay any taxes.
I won’t get into the nitty-gritty details here… but you’ll want to consider this if you have a gain on an existing life insurance policy or annuity.
77. Not understanding the details of your annuities.
Do you have a qualified or nonqualified annuity? Are there any riders? What happens to the riders if the annuity is split? What’s the cost basis?
As you’re gathering information, you want to pull together all the details about any annuities so you can avoid any landmines.
78. Not protecting against the loss of support payments if your ex-spouse dies prematurely.
What happens to your alimony and child support if something were to happen to your ex-spouse? Chances are your support payments would terminate which could leave you in a precarious financial situation.
That’s where life insurance comes in. Life insurance is the cleanest way to protect against the loss of support if something happened to your ex.
If your spouse is uninsurable, there are other options to consider. But beware – they’re not as clean.
79. Continuing to have your spouse own the life insurance policy used to secure support.
If your spouse is the policyowner, they’re in control. What happens if your spouse changes beneficiaries or lowers the death benefit without your knowledge? The last thing you want is to have to show up to probate court to contest their beneficiary designation because it violated the terms of your divorce decree.
If at all possible, consider transferring the ownership of existing life insurance policy into your name. If you’re getting a new policy, then it’s best for the supported spouse to be the policyowner.
Kids and Education Funding Divorce Pitfalls
80. Thinking that 529 plans are your child’s asset.
Technically, 529 plans are not titled in your child’s name. They also can’t be titled jointly.
They are likely in your name or your spouse’s name. If not handled properly, your spouse could withdraw this money and use it for other purposes.
81. Not planning for how to pay for college.
State divorce law varies widely in this area.
For instance, in California, parents have no obligation to contribute financially for college. In other states, parents might still be on the hook.
Regardless, it’s important to have this conversation with your spouse.
82. Making commitments to your children that you can’t keep.
Look, I get it. I know you want to reassure your kids that everything is going to be okay. But, be careful not to make commitments to your kids that you might not be able to keep.
For instance, don’t promise that you will keep the house prior to having that conversation with your spouse.
Even MORE Financial Pitfalls of Divorce
83. Not expecting the unexpected.
Divorce is an emotional rollercoaster. It seems there’s something unexpected at every turn.
Leave yourself a buffer just in case something unexpected happens. For instance, let’s say your spouse loses their job. Not only could you be looking at reduced support, but you might also have to pay attorney’s fees to modify the support agreement.
84. Not understanding that social security is not negotiable.
Social security is a federal benefit. You either meet the requirements or you don’t. Don’t make the mistake of trading some other asset in exchange for social security benefits.
85. Not realizing that certain agreements are not enforceable.
For example, let’s say you and your spouse could sign an agreement that says child support is nonmodifiable. If your former spouse rushes down to the courthouse the next day and files a motion to modify child support, the court will ignore that provision of your agreement.
86. Not considering the potential benefits of delaying finalizing your divorce.
Finalizing your divorce affects a number of issues. Health insurance coverage, tax filing status, social security benefits just to name a few.
Think through the impact of these changes and plan accordingly. In most states, you can finalize the terms of your agreement but delay the termination of marital status.
By doing so, you might be able to benefit financially by filing jointly or remaining on your spouse’s health insurance plan. You might also meet the requirements to take a spousal benefit on your ex-spouse’s social security.
87. Not having your divorce lawyer and Certified Divorce Financial Analyst review your settlement agreement prior to signing.
Okay, so you’ve reached an agreement on property division, support, and custody. You’re nearing the finish line and at this point, you’re probably ready to turn the page to the next chapter of your life.
Don’t cut corners! It doesn’t do any good to have your lawyer and CDFA review the Marital Settlement Agreement after signing. It’s far, far more difficult (and expensive) to try to unwind a signed agreement after the fact.
You owe it to yourself to make sure you understand all the terms of the agreement and any exposure that you may have. Spend the time to sit down with your attorney and go over the MSA. It’s well worth the peace of mind.
A couple bonus tips:
- Prepare a summary of your Marital Settlement Agreement. Your divorce agreement is written in legalese. It has all the protective language to guard against various contingencies. The result? It’s hard to make heads or tails of what it actually means when you have to review it years later. Take the time and prepare a summary of the key terms. I can usually distill a 25-page agreement down to 2-3 pages when you cut out all the fluff and legalese.
- Put together MSA Implementation Checklist. This goes hand-in-hand with the summary. The purpose of the implementation checklist is to list everything that needs to get done. Change title to the car. Close joint credit cards and joint accounts (list them). Refinance the mortgage by ____(deadline). You get the idea.
88. Not recognizing that dividing military benefits in divorce is a whole different animal.
Divorce is based on state law. Military benefits, on the other hand, are governed by federal law.
See the problem?
That’s right. What happens when state law and federal law conflict? Therein, lies the problem.
Federal law trumps state law. In other words, the military does not have to honor divorce agreements if it’s based on state law that conflicts with Federal law.
89. Not realizing that not all assets are equal.
Let’s look at an example. Let’s say you have a 401k worth $100k and a savings account with $100k. You take the 401k and your spouse takes the cash.
Even trade, right? You each have $100k.
Not so fast…
You’re going to pay taxes when you take a distribution from. You might even be subject to early withdrawal penalties. If we assume a 25% tax hit, that $100,000 401k is only worth $75k after taxes. The problem is a savings account and a 401k plan are in different tax “buckets.”
Keep in mind that different assets have different characteristics: liquidity, tax status, income and growth prospects, etc.
You need to take this into consideration in evaluating settlement scenarios.
90. Not clearly identifying your goals and priorities.
It’s absolutely critical that you define your goals and priorities before you begin negotiating with your spouse.
What’s important to you? Why is that important? How would you rank those goals?
Once you have a good sense of what’s important and why – and you have a solid understanding of your financial picture – you can begin to brainstorm settlement ideas.
91. Not considering the value of personal property, such as household furniture, artwork, and collectibles.
Do your best to limit professional time spent on small ticket items. Many counties have personal property arbitration that can help you work through divvying up personal property if you can’t reach an agreement.
92. Not thoroughly reviewing your tax returns.
Your tax returns contain a treasure trove of great information. First, they provide context on your historical income and marital standard of living. It’s a great place to start to identify “hidden” or undisclosed assets if your spouse is less than forthcoming.
If you’ve never looked at your tax return in detail, consider hiring a Certified Divorce Financial Analyst or CPA to go through it.
93. Not investing wisely or developing a post-divorce financial plan.
Investing can be intimidating, especially if you weren’t the one managing the family finances and you don’t have any investment experience.
If you park all your money in cash, you’re basically guaranteeing yourself a slow death (as inflation erodes your purchasing power over time). It can seem risky to put your money in the markets, but it’s also risky to have all your money tied up in cash.
If you’re not a savvy investor, I would recommend working with a financial advisor after divorce that can help you with financial planning and wealth management. Ideally, the financial advisor should have experience working with divorced clients. This will give them a better understanding of your mindset (which is more important than you might think) and they’ll have experience helping with all of the post-divorce financial planning issues (transferring accounts, tracking asset transfers, revising wills and estate plans, and the list goes on).
94. Not practicing self-care during divorce.
Whoa… I thought we were talking about financial pitfalls. I admit this one may not seem like a financial pitfall.
Divorce is stressful and overwhelming. The heightened level of stress can cloud your judgment and take a toll on your immune system.
Taking care of yourself emotionally during divorce is critical to staying healthy which will keep your medical costs down.
95. Overlooking hidden assets in plain sight.
Some assets are easy to overlook, even if your spouse is not intentionally attempting to hide assets.
Here are some of the most common examples:
- Credit card miles/points
- Golf club memberships
- Venmo and paypal accounts
- Health Savings Accounts (HSAs)
- Season tickets
96. Not realizing that Health Savings Accounts (HSAs) can be divided in divorce.
With an HSA, you make pre-tax contributions, the account grows tax-free, and you can use the funds to pay for certain qualified medical expenses.
Many people don’t realize that HSAs can be divided in divorce just like an IRA.
In some cases, the HSA balance is fairly small and it’s not worth the hassle to split the HSA. Another option for handling HSAs is to earmark those funds to be used for children’s healthcare expenses. This way you are effectively sharing those costs.
97. Not turning bad memories into cash.
It can be hard to come to grips with selling your engagement ring (or wedding bad) and symbolically moving on from that chapter of your life.
You might feel like you’re not ready for the next chapter.
But if you’re ready to sell your engagement ring, check out Worthy.com. You can also sell your gold, other jewelry, watches, etc. that you’re ready to part with. And you can use the cash to start saving for your future.
98. Making emotional decisions.
If you know anything about behavioral finance (it’s okay if you don’t), you know that we’re hardwired to make bad financial decisions. This is true even when we’re not facing one of the most stressful periods of your life. Just imagine how hard it is to think clearly when you’re going through a divorce.
99. Not using your divorce as an opportunity to get educated.
I can’t tell you how many people come into my office with absolutely zero clue about their financial situation. And every single one of them regrets not taking a more active role in managing their finances.
There’s nothing you can do to change the past. But that changes today. Never again will you be in the dark about your finances.
You’re now fully responsible for managing your finances and you need to prepare for financial independence. That means getting educated. Do your homework and work with a Certified Divorce Financial Analyst that will take the time to educate you. It’s well worth the investment.
100. Not considering the impact of current jobs on future career opportunities.
Discuss the cost of childcare vs. income if you’ve been out of the workforce for a number of years. You’ve got to play the long game. Sure, it might not make sense in the short-term to take a low paying job if the childcare costs are the same as your income. But will that job set you up for future success?
101. Not recognizing your emotional hot buttons and developing a strategy for when you get triggered.
If you’ve been married for some time, there’s bound to be a number of things that can set you off in an instant.
Think ahead about what you’re going to do when your spouse (inevitably) says or does something that drives you up a wall. Perhaps you’ll tell the mediator that you need a break or tap your attorney under the table so they can call a time out.
It doesn’t matter what you do as long as you have a plan and stick to it. If you allow yourself to get triggered, that can derail settlement negotiations and drag things out.
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