Stories of divorce settlements resplendent with overlooked assets, lost opportunities and glaring tax gaffes abound in financial planning circles. Too often, the first time divorced people consult planners is after their divorces are finalized, when they're pretty much stuck with whatever settlement they agreed to. That's precisely why a growing number of planners like Virginia's Donna Miller are making sure clients know up front that they can and should turn to their planners for help in valuing and dividing assets.
"We put the fact that we offer divorce planning in our yellow page ads and up on a board in our office, so clients know we're here to help them," says Miller, who is president of the planning firm of Miller Musmar, with offices in Manassas and Reston, Va.
Divorces are rising to planning prominence for a slew of reasons, not least of which is the mounting number of them: A full 50% of marriages end in divorce these days (sadly, the divorce rate rises to 60% for second marriages). Not surprisingly, planners are seeing these divorce rates hit clients and would-be clients hard. As a result, more advisors are reaching out so that clients know they don't have to go it alone. "The last thing in the world you want is for someone to assume that their divorce attorney will look after their financial well-being," says Nancy Kaye, president of $ound View Financial Services in Port Washington, N.Y. "I'm not trying to lawyer bash, but it simply may not happen. Attorneys may look at a few assets, but there will be no comprehensive plan or understanding of the aftermath of a settlement."
While divorce attorneys should be well-versed in state laws regarding the formula for child support and rule-of-thumb calculations for spousal alimony, they may or may not know how to value a pension plan or do an after-tax analysis on assets, Miller says. "Most do not advise that a financial or tax advisor is necessary, so right away people aren't getting good advice, and there is always one spouse who is less financially astute."
Lawyers also may not be willing or able to present clients with more creative options, such as using IRS rules to annuitize assets to meet a divorced person's current need for cash flow. And because it's really not their bailiwick, attorneys also are much less likely to do cash-flow analysis and asset projections to give clients a realistic view of what their actual standard of living will look like, post-divorce, Miller adds.
Advisors, however, do all these things. And by helping clients keep assets, they increase their own business. That's why it's important that planners make it clear that they can assist clients before, during and after divorce proceedings. Here are some of the leading issues advisors are helping clients who are facing divorce tackle:
Know the rules so you can break them. Knowing the minimum child support required by state law calculations and the general rule of thumb for determining alimony can help clients prepare for and negotiate better settlements. Attorneys often present these numbers as de facto, when actually the numbers are merely the minimums required by the state. "I'll ask, 'Do you really want to pay your child just the minimum?'" says Kaye, who often does planning jointly for divorcing couples. Knowing the rules also gives clients a tool for negotiating what they need, instead of accepting a cookie-cutter settlement. Maybe a divorcing client is willing to forgo some alimony (which is subject to income tax) for larger monthly child support payments (which are tax-free). Miller also suggests that the child exemption be negotiated, instead of awarding it to the higher-income spouse, who may not be able to use it.
Value's value, right? While attorneys may not understand the actuarial essence of present value, planners should. Depending on where you practice, stock options and pensions may make up a huge amount of the assets up for grabs in a settlement. Ensuring that these are valued appropriately, that tax-efficient planning is employed and that the timing of their distribution is spelled out in a divorce settlement may sound like no-brainer, but it doesn't always happen without planning advice. With division of pensions, for instance, many attorneys use an "if, as and when" valuation, which means "if, as and when" your former spouse takes her pension, so will you get yours.
"I like to do a present valuation of pension assets now," says David Twenhafel, a Rockville, Md.-based CFP and certified divorce planner (CDP) who has done work on 200 divorces in the past four years. "When we find what we assume the asset will be worth down the road, it gives us something to trade on today." Accurate valuations also are critical from a tax perspective. The last thing a planner wants to see is a client end up with a 50% division of property made up of appreciated and taxable assets, while the ex gets 50% cash, tax-free.
Timing is everything. Assets like stock options also can present hairy situations, especially if a settlement gives a former spouse several years to exercise. Generally, assets transferred more than one year after a divorce is final can trigger taxes. What about post-divorce transfers? They are tax-free only if they are considered an "incident to divorce." For later transfers, spell out in the settlement that they are "related to the cessation of the marriage" and part of the property settlement. The transfers must take place within six years of the divorce. Also keep in mind that tax-free transfer privilege only applies to capital gains. So if clients transfer investments with accrued ordinary income (such as Treasury securities or corporate bonds between interest-payment dates, U.S. savings bonds or stock after the ex-dividend date but before the payment date), they are taxed on the ordinary income.
What's a QDRO? A qualified domestic-relations order is the legal document that spells out distribution of pension and qualified-plan assets. It's the road map that plan administrators use. It is also one of the leading areas of malpractice suits against divorce attorneys, according to the American Bar Association. Why? Attorneys don't always get it right when it comes to moving assets in a tax-advantaged way. The result can be taxes and penalties. Tom Treacy, president of Innovative Financial Planners Inc. in Stony Brook, N.Y., shares an office suite with a divorce attorney and prepares upward of 50 QDROs a year. "It's crucial that clients clearly understand their options, so that large sums don't needlessly get eaten up by taxes," he says. A smart move for avoiding taxes and the 10% early withdrawal penalty? Use a QDRO to move qualified-plan assets into an ex's IRA. If the ex needs income, you can also use the QDRO to set up periodic payments (SEPPs). Treacy says that at a recent seminar for divorce attorneys he attended, more than 30% did not know that the IRS allows penalty-free annuitization for five years.
Who gets the house? Sometimes it's cleanest for spouses to sell a jointly owned property and, when possible, take advantage of the $500,000 capital-gains exclusion. If a couple owns more than one house, and one has been a rental property, Miller advises that one ex live in the former rental property for two years, so the capital-gains exclusion (which requires that a property be a primary residence in two out of five years) is available on that property. If one spouse is determined to keep the primary residence, planners should make sure that the break is a clean one. Divorce attorneys are famous for leaving former spouses' names on mortgages, which not only ties up credit, but exposes them to foreclosure if their exes stop making mortgage payments. "It also pays to know mortgage options," says Twenhafel. "Sometimes clients don't know they can obtain a mortgage without income, if they have enough assets."
This is your new reality. Spreadsheets of clients' cash flow give them both a macro and micro view of what their financial lives will look like after the divorce. What does their monthly cash flow look like? How about retirement and college planning? Can they really afford to keep the house, or would trading down make life a lot easier? What about life and health insurance? This step can help cement an ongoing planner-client relationship.
Penny-wise and pound-foolish. Communicate the advantage of using financial planning services in achieving an attractive settlement in both your written materials and at least once a year in client conversations or meetings. It plants the idea that you're there to help navigate all of life's financial challenges and ensures that your name is on the tip of their tongue when divorcing family members, friends or co-workers need financial advice.
Know The Experts
If you're bad at working with divorcing clients or inexperienced, and some advisors readily admit they are, partner with a planner who likes the challenge. The Association of Divorce Financial Planners (www.divorceandfinancial.com) is a starting place. Unfortunately, the Institute for Certified Financial Planning has been disbanded. Equally important: Know competent and capable divorce attorneys and mediators in your area. That's especially true because the average divorce can cost as much as $30,000, according to the American Bar Association. "Most clients working toward divorce haven't found an attorney yet," says planner Nancy Kaye of New York. If a client and his or her divorcing spouse are candidates for mediation, you might suggest it, which can cost as little $750. To find a mediator in your area, contact the Academy of Family Mediators (www.mediators.org).