Divorce and Your Finances
It is no secret that financial problems in a marriage can be a significant factor in a couple’s decision to get a divorce. In fact, a recent report found that 13 percent of divorced student loan borrowers blamed their student loan debt for the dissolution of their marriages.
It’s also no secret that the financial fallout from divorce can leave spouses struggling to pick up the pieces.
While the divorce rate in the U.S. is dipping slightly for younger couples, so-called gray divorce is on the rise. The divorce rate for couples 50 years and older has nearly doubled since 1990, and tripled for those ages 65 and older, according to data from the National Center for Health Statistics and U.S. Census Bureau. Divorce in older couples has the potential to be even more financially devastating because they are entering (or already in) retirement.
Related: 5 Ways Moms (and All Women) Can Take Charge of Their Financial Futures
We all hope our marriages will be successful, but sometimes life just doesn’t go as planned. Whether you are currently working through a divorce, or just want to be prepared, here are six tips to consider that can help you better understand—and stay in control of—your investments.
1. Update Account Beneficiaries
There are a number of reasons you may want to update your beneficiary designations on your investment accounts. Divorce might be one of them. If you don’t want your spouse to be the beneficiary to your investment accounts, take the time to contact your financial professional and remove your spouse’s name and designate one or more new beneficiaries. This can help avoid a messy situation for all parties involved.
2. Get Access To Investment Accounts
In many families, spouses divide the household tasks. One person cooks and the other is on dish duty. Often, one person will be in charge of the family finances and manage the accounts to make sure bills are paid and investment accounts are handled appropriately. If you are not this person in your relationship, take some time to ensure you have the information you need to access information about all of your assets, including your investment accounts.
Ask yourself a few questions: Do I know about all of the investment, bank or other financial accounts that make up the assets I may be entitled to? How is each account set up (in my name only, my spouse’s name only, jointly held or some other way)? Do I have the account numbers, login credentials, contact information and other necessary information to access these accounts? Am I able to make decisions in these accounts and place a hold on withdrawals if necessary? It will pay to understand where things stand should something go wrong down the road.
3. Taxes and Other Penalties
Before you sell any assets, consider the tax consequences and other possible costs or penalties. In standard, taxable accounts, selling securities can trigger capital gains taxes. And some assets, such as annuities, can come with steep penalties if you exit the investment early. There's also the question of timing—if your divorce happens to take place during a market decline, it might not be the most opportune time to sell. And liquidation of or early withdrawal from certain investments, such as retirement accounts, may carry penalties, discussed more below. Another option is to keep your holdings and divide shares evenly between the spouses, so you don’t have to worry about taxes or penalties if they can be avoided.
4. Dividing Up Taxable Investment Accounts
Splitting up assets between spouses will be subject to different processes, depending on the type of investment account. For taxable accounts, such as a brokerage account you own jointly with your spouse, you typically must provide a letter to the financial institution requesting that the joint account be closed and that new, separate accounts be opened in each person's name. The letter should detail how the investment assets will be allocated between the two accounts. If one spouse is moving assets to an account with a new firm, it’s important to note that not all assets, such as proprietary investment funds or insurance products, may be transferable and liquidating such products may result in financial penalties, tax consequences and fees.
Your situation might call for immediate action if you're worried about actions your spouse may take regarding a joint brokerage account—investments or withdrawals you disagree with, for instance. You can contact your financial institution and ask that the account be frozen until you reach an agreement on how to divide your assets.
5. Splitting Up Retirement Accounts
In most states, retirement account assets generally are considered marital property, which means your spouse may be entitled to a portion of these assets. Many couples include specific terms about what will happen to retirement account assets in their divorce or settlement agreements. Dividing up retirement assets gets a little complicated because different information is required and different rules apply depending on the type of account. Keep in mind that how you divide an account might trigger taxes and fees that you will likely want to avoid, if possible.
To split employer-sponsored 401(k) or 403(b) plans, or a pension plan, you are typically required to provide a court order known as a Qualified Domestic Relations Order (QDRO) to the plan administrator (usually this is your employer). Each plan has its own guidelines that will determine how the assets can be divided. Some plan administrators allow the non-employee spouse to open his own account within the plan, while other plans will require a rollover into an IRA, or for that spouse to take a penalty-free distribution. Generally, for 401(k) accounts and pension plan assets, a QDRO allows the funds in the retirement plan to be separated and withdrawn without penalty.
When it comes to dividing up IRAs, there is no QDRO. IRA plan assets are divided based on the terms of the couple’s divorce decree or separation agreement. Such agreements must be submitted to the IRA custodian. The only way to split an IRA in a divorce and not incur taxes is to have a court-ordered divorce decree and roll the separated funds into a new IRA.
If you receive assets from your spouse’s retirement plan and want to cash out the assets by taking a distribution, here is what you need to know about distribution penalties:
- Distributions from a qualified plan pursuant to a QDRO are exempt from the 10 percent early distribution penalty, so if you are younger than age 59½ you are able to receive a penalty-free distribution.
- However, these exemptions do not apply to IRAs. Once the assets are rolled over into an IRA, they no longer are exempt from the 10 percent penalty on early distributions, so any funds taken before age 59½ would likely be subject to an income tax and an early-withdrawal penalty.
Lastly, when considering how to evaluate the amount you might receive from a retirement account in a divorce, remember that withdrawals from a traditional 401(k) or IRA account where contributions are made before taxes will be taxed differently than those from a Roth account where you pay taxes on contributions, but generally not on withdrawals of earnings and contributions. A case in point: $300,000 in a traditional account will be worth less than the same amount in a Roth account, since the traditional account withdrawals will be subject to taxes.
6. Enlist the Help of Professionals
Dividing financial assets during divorce can be overwhelming, so you might consider asking for guidance from your attorney. A lawyer with the right experience can help with estate planning and other investment-related issues. You may also consider working with a broker or other type of financial professional and an accountant to understand all the tax implications. FINRA offers a series of steps to follow when it comes to finding and doing business with a financial pro. A key step is to see if the individual you are considering is registered.
There are many types of investment professionals. But when it comes to buying and selling stocks, bonds and other securities products, only individuals and firms registered with FINRA (brokers), the Securities and Exchange Commission (certain investment advisers) and in those states where required by law, can do so. Check out brokers or investment advisers using FINRA BrokerCheck.
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