Divorce and Your Finances

Keeping an eye on your financial health during a divorce is essential. This report outlines the rules that may apply and offers tips on some traps to avoid.

Divorce can be a complicated and challenging process in which details are easily overlooked. Protecting your financial health during this time is crucial, and no one should enter this process without a trusted attorney (specializing in divorce) on his or her side. Equally important is knowing the laws that shape divorce proceedings, and the impact they can have on your assets.

Dividing the Assets

Typically, everything you and your spouse acquired from the day you were married is subject to division. The exceptions are individual inheritances, gifts to an individual spouse, and assets acquired before marriage. When assets are divided, the court considers each spouse's earning ability, the length of the marriage, and how much each spouse contributed to building household assets.

The exception to this are the nine "community property" states -- Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Under the laws of these states, almost all assets will automatically be divided equally.

Don't try to hide assets from the court, either by neglecting to mention them or transferring them after the proceedings have begun. This can trigger an "omitted asset" penalty and force the court to redivide your property.

Dealing With Debt

Don't assume that a divorce will erase any debt. If you live in a community property state, debt -- like your assets -- will be split down the middle. You will be responsible for half of all debt in jointly held accounts and, in some cases, for half of a spouse's individual debt as well.

If you don't live in a community property state, you remain responsible for your individual debt (but not your spouse's) and any debt in jointly held accounts. One important trap to avoid is maintaining joint accounts after the divorce. Your spouse could continue running up expenses and leave you with the debt. As soon as the divorce is finalized, freeze all joint accounts and have your creditors reclassify them as individual accounts. Most creditors will do this at your request, though they are not legally required to do so. To protect your credit rating, make sure to keep up with monthly payments.

In addition, include the payment of debt as part of the settlement. Take on the responsibility for the debt yourself, if necessary, and take a share of the assets to pay the debt down.

If you and your spouse own a home that has appreciated in value, you may want to sell it before the divorce is finalized. Federal tax rules offer an exclusion of up to $500,000 in realized capital gains for married taxpayers. This amount is cut in half for single filers. Be sure to consult a tax advisor for additional information about these rules.

Tax Relief for Innocent Spouses

Divorce will not protect you from the IRS. If you filed jointly with your spouse, you can be held liable for delinquent taxes.

In 1998, Congress enacted legislation that offers protection to spouses who filed joint returns, relieving them of paying taxes that are the responsibility of an ex-spouse. The law also allows an innocent spouse to limit tax liability if he or she has been living apart from the delinquent spouse for at least 12 months from the time the joint return was filed. Talk to a tax advisor about how this information relates to your own situation.

Your Retirement Assets

Money in your 401(k) or pension plan may legally be divided during a divorce. The divisible amount typically begins to accumulate on the day you are married and ends on the day you are divorced.

To claim a share of a spouse's 401(k) or pension plan benefit, you need to obtain a court order called a Qualified Domestic Relations Order (QDRO) and provide it to your spouse's plan sponsor before distributions are completed to your spouse, which prevents your spouse from making withdrawals.

You and your spouse can decide to not divide your 401(k) assets or pension plan benefits, but you should make this agreement in writing and include it as part of the settlement to prevent the courts from declaring the money divisible.

If there are outstanding loans against a 401(k) and only one spouse was able to contribute, the noncontributing spouse may be exempt from paying back the loan. However, if the purpose of the loan was something that benefited both spouses -- such as a home -- the noncontributing spouse's share of the assets may be reduced to facilitate repayment of the debt.

If you do receive a share of a spouse's 401(k) assets or pension plan benefit, it may be best to roll over your share immediately into an individual retirement account (IRA) to avoid taxes and maintain tax deferral. You should discuss this with your attorney or a financial advisor familiar with divorce proceedings as soon as you anticipate a divorce.

Estate Planning

Be sure to review your will or, if you don't have one, draw one up. You should consult an attorney familiar with your state's estate laws to ensure that your assets are properly distributed. Do not wait until the divorce is final. You should review and amend your estate plan at the same time you decide to commence a divorce proceeding. Also make sure to review beneficiary designations for pensions, 401(k)s, and life insurance policies. Federal law requires a spouse to be the sole beneficiary of pension or 401(k) benefits unless that right is waived in writing by the spouse.

If you find yourself faced with divorce, it is essential to protect your financial future. Enlisting the help of an attorney and carefully monitoring the process can ensure that your interests are considered and that you won't need to revisit the proceeding later on.

Next Time, Should You Have a Prenup?

A prenuptial agreement can be a valuable tool for protecting your finances. These documents are difficult to contest in the event of a divorce. The prenup should be drawn up by both you and your spouse with the assistance of attorneys, and should include:

• Current assets and debts
• Financial arrangements (such as alimony payments)
• Estate and inheritance plans
• Financial care and custody of children from previous marriages
• How assets will be divided in case of a divorce

Finally, include in your prenup a future date to review this document. Should circumstances change, you can then amend the agreement.

Summary

• The division of assets in a divorce depends on the state where you live.
• Be sure to include debt resolution as part of the settlement, and be sure to continue making payments on any outstanding debt.
• Once the divorce is granted, freeze all joint accounts and have them converted to individual accounts.
• Unless waived in writing, 401(k) and pension plan benefits are divisible during a divorce by a Qualified Domestic Relations Order.
• Review your beneficiary designations for 401(k) plans, pension plans, and life insurance policies.
• Review your will, or draw up a new one.

 Source: Yahoo Finance