Divorce Settlements are all too often the result of a dangerous combination of strong emotional feelings and a lack of knowledge. What you end up with is an unfair settlement that leaves one party with significant financial challenges, that often can take years to overcome. With just a little bit of knowledge, along with some professional help, these situations can be avoided.
The first thing to understand about your divorce settlement is that you MUST go into the negotiations with a realistic expectation for an outcome. Sit down and spend some serious time thinking about what you want from your spouse, and more importantly spend time researching previous rulings and your local laws to determine what is a reasonable outcome. With that in mind, here are some common mistakes that people make when going through the process.
- Liquid vs. Illiquid Assets
To anybody with a financial background, this distinction will be almost second nature, but for the majority of us, it requires a bit of thought. The liquidity of an asset refers to how easily it is convertible into cash. A checking account for example is extremely liquid, whereas a house is very illiquid. Often a settlement will award one spouse most of the more liquid assets such as investment accounts and pension plans, and the other spouse will get the less liquid assets such as vehicles and house. Too often this leads to a serious cash flow problem for the spouse with the less liquid assets, as they are unable to pay the expenses and costs associated with the house and cars and are forced into selling them. This presents a serious problem, because an illiquid asset such as a house it very difficult (and costly) to sell in a hurry, so often the owner is forced to take a below market price, making things even more difficult.
- Tax Implications
Another somewhat hidden issue to consider is that of taxes. When coming to an agreement with your former spouse, you must consider the ‘tax value’ of the asset rather than simply focusing on the market value of the asset. A perfect example is an investment account. If a married couple had investments of $100,000.00 with a cost base of only $20,000.00, then the difference of $80,000.00 is most likely subject to capital gains. So an investment account with a market value of $100,000.00 can be worth much less than that in real-world money if the spouse needs to sell those assets to pay expenses. Another example is income taxes. Alimony and child support are both typically taxed as regular income. So if your spouse agrees to pay you $2000 a month in alimony, that money will be taxed and you will receive much less than that in your pocket each month. At the same time, the $2000 a month is a tax deduction for the party who is paying it, so it’s actually costing that spouse less than $2000 a month.
- Hidden Assets
Unfortunately, divorce often brings out the worst in people and many times this results in deception or outright lying in the divorce settlement process. The most common form of this is hidden assets, where one party does not fully disclose their financial situation during the negotiations. It is highly recommended that if you suspect at all that your former spouse has any assets they are not fully disclosing to you, that you hire a forensic accountant to audit their financial situation. This is especially important if your former spouse is a business owner, as there are many options available for a business owner to shelter assets or liabilities in such a manner as to be difficult for an outsider to understand. A great way to probe for hidden assets is to ask that your spouse hand over all tax returns from the last 5 years. If they are unwilling to do this, you should suspect they are hiding assets.
When negotiating a divorce settlement it is important that you be pro-active. Keep the above common mistakes in mind, and be sure to bring them up with your lawyer if they don’t seem to be addressing them.