Divorce and money: Common pitfalls to avoid

Divorce and the resulting legal challenges have been thrust into the spotlight after Amazon CEO Jeff Bezos and his wife MacKenzie announced they will divorce after 25 years of marriage.

There are many tricky issues couples need to iron out during divorce proceedings and finances are often a big focal point – particularly for the Bezoses.

However, since the average American couple has far less wealth to worry about than Jeff and MacKenzie Bezos, there are some easy ways individuals can avoid falling into common pitfalls.

First and foremost, it is important to consult financial and tax advisers throughout the process.

“What many do is rely on their lawyers and they don’t understand that lawyers have legal training, not financial training,” Ric Edelman, a founder of Edelman Financial Engines, told FOX Business. Edelman added that oftentimes lawyers will advise clients to split all the assets 50-50, when in reality, that’s too simplistic.

For example, when it comes to a stock portfolio, a lawyer might be prepared to accept a 50-50 split in assets. However, just because assets are technically equal in outright value, doesn’t mean they are otherwise equal in terms of liquidity, taxability or income and growth potential.

Here are some other things to keep in mind throughout the proceedings:

State laws

The laws for splitting property vary by state. There are equitable distribution states, like New York, and community property states, like California. In the latter, all assets acquired during the marriage are considered marital property and subject to a 50-50 split. In an equitable distribution state, more assets are considered marital property, but the split doesn’t necessarily have to be 50-50.

Aside from a prenuptial agreement, another way to make sure some of your assets, like an inheritance for example, are protected is to never let them touch a joint account. Once they do, they are considered marital property. Instead, Edelman says you should put things like an inheritance into a trust. You can also keep a separate, personal account to protect yourself.

Kelly Frawley, partner at the matrimonial and family law department at Kasowitz Benson Torres LLP, also said people should not allocate money acquired during marriage toward accounts that predate the union – because once an individual begins to co-mingle funds, it can be argued that the account is marital property.

The house

“The biggest mistake that people make pertaining to the financial distribution of assets starts with the house,” Edelman said.

Typically, one spouse will leave the home to the other, for the sake of not uprooting or disrupting children’s lives, among a variety of other reasons.

The problem is that the house is often purchased based on the pair’s dual incomes and, after a divorce, the single partner often can’t afford to maintain the property causing “massive strife and an inevitability of having to sell the house anyway,” Edelman said.

Therefore, the first thing a divorcing couple should do is consider whether it makes sense to keep or sell the property.

Retirement accounts

To the extent that partners contribute to retirement accounts during a marriage, that money would be considered marital property and subject to division during divorce proceedings.

Frawley recommends saving the quarterly account statements from the year of marriage, so that, in the event of a divorce, an individual can show what money had been accumulated prior to the partnership – and that money would be given solely to that person.

For shared accounts, it is important to note that once a couple agrees to split the contents, they can’t go through with it until a judge orders it.

“The reason you have to wait for a judge is because if you don’t and distribute half the money, the IRS will consider it a withdrawal, which is subject to taxes and a 10 percent penalty,” Edelman noted.

Debt

The debt one party brings into the marriage under her name, she would take out of the marriage – for example, something like student loan debt.

Edelman notes that payments the other spouse makes toward this debt can be reclaimed.

The nature of the debt and when it was incurred often has implications for the division of assets.

Frawley cautioned that, throughout the divorce planning process, it may be wise to keep an eye on a partner’s payments, because he may try to pay down debt using his spouse’s money before the assets are divided.

Taxes

The big tax issue for a couple considering divorce is the change in the deductibility of alimony payments. As stipulated under the Tax Cuts and Jobs Act, beginning in 2019 the payor will no longer be able to deduct alimony and the recipient won’t have to include it as income. Because the payor is generally in a higher tax bracket than the payee, the deduction helped reduce this individual’s taxable income.

Now there is less incentive for the higher-earning spouse to pay alimony.

The tax laws governing child support, however, remain the same, which is likely to lead the payor to try to allocate more money toward child support and less toward alimony.

However, child support is paid for a defined period of time, whereas alimony is usually a longer-term arrangement, Edelman pointed out. This could lead to some complications for divorces finalized after January 1.

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Prevention

Both Edelman and Frawley said they have seen an increase in the number of prenuptial agreements, especially among the younger generation, which, ironically, tends to have fewer assets to protect.

Edelman said this trend – which has traditionally been observed among older, wealthier couples – is happening for two reasons, the first being that younger Americans are less likely to believe their marriage is going to withstand the test of time. The second reason is that this demographic is saddled with student loan debt, and a prenuptial agreeement can spell out terms for repayment if the parties pay off each other’s dues during the marriage.

But perhaps the easiest way to make sure your finances remain intact is to avoid divorce altogether.

“Many of the financial issues that lead to divorce could’ve been identified prior to the wedding,” Edelman said, referring to knowledge of things like debt, income and savings. “Had they learned [about these things] prior to the wedding, the wedding would’ve never taken place.”