As a financial planner, you can't help a divorcing client deal with all the difficulties of a dissolving marriage. You can, however, help protect his or her financial security for the future.
Some advisers seek to specialize in divorce planning, while others work with divorcing clients as the need arises. No matter how you and your business handle divorce planning, be sure to take a multifaceted approach to your client's finances and consider the following safeguards.
Establish a spending plan.
The reality of every divorce is that both parties will need to adjust their lifestyles — and spending plans. To begin, ask your client to create a record of annual and monthly expenses based on recent history. Then, assess his or her emergency fund and, if needed, develop a plan for building one up. With this information, you can begin to create a new strategy for saving and investing.
Create a net-worth statement
Putting together a net-worth statement is the next order of business. This schedule will identify marital and separate assets and debt, as well as each asset's tax basis.
The definition of a marital asset differs from state to state, but you can still follow these relevant guidelines:
• Consider anticipated income from dividend-paying stock of a closely held business, royalties and rental property.
• Analyze retirement income. Retirement plans may be private plans offered through employers, as well as public plans offered through federal, state or local agencies. Valuation will depend on the characteristics of the retirement plan.
• Review the tax characteristics of different assets, particularly if they'll be liquidated shortly after the divorce. For instance, a cost basis review will help allocate capital gains between the parties, as will a comparison of qualified assets to nonqualified assets. Other factors to consider are transfer or liquidation restrictions, surrender charges and lack of marketability.
Bear in mind that fair market value may be affected by the date of determination, such as the date of separation, trial or declaration of intention to divorce.
Take steps to guard credit
Taking immediate steps to identify all debt and protect credit may be an important step for your client. Suggest that he or she:
• Ask for a credit report from one of the three major reporting agencies: Equifax, TransUnion or Experian.
• Review credit card or debit card accounts or lines of credit and determine if any should be closed or need a change in authorized users. Focus on paying the balance in full.
• Freeze a home equity line of credit, even if there's no balance. This line of credit is like a blank check and will result in a lien on the home; the same is true for brokerage margin accounts.
Protect jointly held assets
Neither spouse should sell or transfer marital assets without an attorney's guidance until the divorce is final. The attorney may recommend splitting the cash accounts into two individual accounts so that both parties have the liquidity they need. For the remaining accounts, consider whether duplicate statements or restricted authorization may be appropriate.
Offer a realistic point of view
Settlements are expected to be equitable, but it may not be a literal 50/50 split of assets. One spouse can be awarded more property to compensate for the other's ability to earn a higher income, or one spouse may be willing to trade a higher-value item for one that is more liquid. Help your client see the big picture, ensuring that he or she is aware of the short- and long-term effects of the settlement by projecting the impact on retirement, education and cash flow planning.
Perform a tax analysis
Division of property, payment of alimony and receipt of child support all come with tax implications. Test the after-tax values of various combinations of property division, alimony and child support. As a general rule, no gain or loss is recognized when assets are transferred between ex-spouses within one year after the date of divorce. The transfer can occur anytime within six years of the divorce if a separation or divorce agreement instructs the parties to make the transfer.
Protect the future
If your client's financial future would be at risk in the event of the death of the ex-spouse, suggest life insurance on the life of the ex-spouse as a condition of the divorce settlement.
Check, check and check again
Divorce planning is complex and highly detailed. To avoid current taxation or other penalties, your financial decisions must adhere to a court-ordered property division, divorce or separation agreement. Check, check and check again with the attorney, employers, custodians and insurance companies before moving any financial assets.
Help your client take control
When the dust settles and your client can see beyond today, it is a good time to help him or her explore options for the future. This may include a change of scenery, a new career or going back to school. No matter how your client chooses to build his or her future, you can create a solid financial plan to help turn dreams into realities.
Rose Watson is a manager, advanced planning at Commonwealth Financial Network, where she provides support to the firm's financial advisers in all areas of financial planning. A copy of this blog originally ran on Commonwealth's website.