The Financial Challenges of Divorce: How to Prepare

 

Divorce is a life-altering event that brings emotional and financial challenges. The dissolution of a marriage often requires a complete overhaul of one’s financial plan to ensure stability and independence moving forward. Below are some key financial planning changes that need to be addressed during a divorce to secure your financial future.

 

1. Assess and Reorganize Your Budget-Divorce typically means transitioning from a shared household income to a single income, which can significantly impact your financial situation. Creating a new budget is critical to understanding your financial needs post-divorce.

• Evaluate Income and Expenses: Calculate your individual income, including any alimony or child support, and compare it to your expenses. Factor in new costs, such as housing, utilities, or insurance, that may no longer be shared.
• Prioritize Essential Expenses: Focus on necessities like housing, food, transportation, and healthcare. Cut discretionary spending where possible until your financial situation stabilizes.
• Emergency Fund: Build or maintain an emergency fund (ideally 6–12 months of living expenses) to cover unexpected costs, as financial uncertainty often increases during and after a divorce.

 

2. Divide Assets and Liabilities-Dividing marital assets and debts is a cornerstone of divorce proceedings, and it has significant implications for your financial plan.

• Understand Marital vs. Separate Property: Identify which assets (e.g., homes, retirement accounts, investments) and debts (e.g., mortgages, credit card balances) are considered marital property, as these are typically subject to division. Separate property, such as assets owned before the marriage may remain yours, but confirm with legal advice.  As an example, typically an inheritance that was never comingled with spousal assets in not subject to marital division.
• Retirement Accounts: Splitting retirement accounts like 401(k)s or pensions often requires a Qualified Domestic Relations Order (QDRO). Be aware of potential tax implications and penalties for early withdrawals.
• Debt Responsibility: Ensure clarity on who is responsible for joint debts. Monitor your credit report to avoid surprises from debts your ex-spouse was supposed to pay.
• Hire Professionals: Work with a financial advisor and divorce attorney to ensure equitable division and to understand the long-term impact of asset splits, such as tax consequences or liquidity issues.

 

3. Update Legal and Financial Documents-Divorce necessitates updating critical documents to reflect your new status and protect your interests.

• Beneficiaries: Review and update beneficiaries on retirement accounts, life insurance policies, and other financial accounts. Failing to do so could result in your ex-spouse receiving benefits intended for someone else.
• Wills and Trusts: Revise your will, trust, and estate plans to reflect your new wishes. Update powers of attorney and healthcare proxies to remove your ex-spouse if necessary.
• Bank and Credit Accounts: Close joint bank accounts and credit cards to prevent future liabilities. Open new accounts in your name and ensure your credit score is protected.
• Insurance Policies: Update or obtain new health, auto, and homeowners/renters insurance policies. If you were covered under your spouse’s plan, secure new coverage before the divorce is finalized.

 

4. Reevaluate Retirement and Investment Goals-Divorce often disrupts long-term financial goals, particularly retirement planning. Adjusting your strategy is essential to stay on track.

• Recalculate Retirement Needs: Losing a portion of retirement savings or a spouse’s income may require you to save more aggressively or delay retirement. Working with a qualified financial advisor can help plan for such changes.
• Investment Strategy: Reassess your investment portfolio to align with your new risk tolerance and financial situation. For example, you may need more liquid assets in the short term or a more conservative approach if your income is reduced.
• Social Security Benefits: If you were married for at least 10 years, you should be eligible for Social Security benefits based on your ex-spouse’s earnings, even if they remarry.  If your earnings were higher, then that won’t be necessary.  Consult with a financial planner to understand your options.

 

5. Address Spousal and Child Support-Alimony and child support can significantly impact your cash flow, whether you’re receiving or paying them.

• Receiving Support: If you’re receiving spousal or child support, incorporate these payments into your budget but plan for the possibility that they may end (e.g., spousal support often has a set duration). Save or invest these funds to build long-term financial security.
• Paying Support: If you’re paying support, ensure these obligations are factored into your budget. Understand the tax implications, as spousal support is no longer deductible for the payer or taxable for the recipient for divorces finalized after December 31, 2018, under U.S. tax law.
• Child Support Considerations: Child support typically covers expenses like education, healthcare, and extracurricular activities. Plan for these costs and ensure they’re clearly outlined in the divorce agreement.

 

6. Protect Your Credit and Financial Independence-Divorce can impact your credit score and financial independence, especially if you relied on your spouse’s credit or income.

• Monitor Your Credit Report: Check your credit report for errors or unauthorized activity, especially if joint accounts were involved. Services like Experian, Equifax, or TransUnion can provide free reports.
• Build Your Credit: If you lack a strong credit history, establish one by opening a credit card in your name, paying bills on time, and keeping your balances low.
• Avoid New Debt: Be cautious about taking on new debt during the divorce process, as legal fees and lifestyle changes can strain your finances.

 

7. Plan for Housing Changes-Housing is often one of the biggest financial considerations in a divorce.

• Decide on the Marital Home: Determine whether to keep, sell, or refinance the marital home. Keeping the home may require refinancing the mortgage to remove your ex-spouse’s name, which could affect your budget.
• Renting vs. Buying: If you move out, evaluate whether renting or buying a new home makes sense based on your income, local housing market, and long-term goals.
• Factor in Costs: Account for new housing-related expenses, such as property taxes, maintenance, or rent, in your budget.

 

8. Seek Professional Guidance-Navigating the financial complexities of divorce can be overwhelming, so working with professionals is highly recommended.

• Financial Advisor: A Certified Financial Planner^® (CFP^®) or divorce financial analyst (CDFA) can help you create a post-divorce financial plan, optimize asset division, and plan for long-term goals.
• Divorce Attorney: A lawyer ensures your legal rights are protected and helps negotiate fair terms for asset division, alimony, and child support.
• Tax Professional: Divorce can have significant tax implications, such as changes in filing status or capital gains taxes from selling assets. A CPA can help you minimize tax liabilities.
• Therapist or Counselor: Emotional stress can cloud financial decisions. For some people, a mental health professional can help you stay focused and make rational choices.

 

9. Plan for Your Children’s Future-If you have children, their financial needs must remain a priority.

• Education Savings: If you have a 529 plan or other education savings accounts, clarify who will manage and contribute to them post-divorce. Update account ownership if necessary.
• Life Insurance: Consider maintaining or purchasing life insurance to ensure your children are financially protected in case of your untimely death.
• Evaluate your health and disability insurance to ensure that both you and your children are adequately covered in the event of an accident or medical emergency.
• Co-Parenting Expenses: Create a clear plan for sharing costs like healthcare, extracurricular activities, or college expenses to avoid future disputes.

 

10. Embrace a New Financial Mindset-Divorce is an opportunity to take control of your financial future. Educate yourself on personal finance, set new goals, and build confidence in managing your money independently.

• Financial Education: Take courses or read books on budgeting, investing, and retirement planning to boost your financial literacy.
• Set New Goals: Whether it’s buying a home, starting a business, or traveling, create a vision for your future that aligns your financial plan with those aspirations.
• Stay Disciplined: Stick to your budget, avoid impulsive spending, and regularly review your financial plan to stay on track.

 

Divorce is a challenging process, but addressing these financial planning changes can help you emerge with a solid foundation for your new life. By reassessing your budget, dividing assets thoughtfully, updating legal documents, and seeking professional guidance, you can navigate the financial complexities of divorce with confidence. Take proactive steps to protect your financial independence and build a secure future for yourself and your family. Consulting with a qualified financial advisor can offer a great deal of value when navigating these challenges.