When financial mistakes are made in divorce, the resulting errors in your settlement can have long-lasting consequences, impacting your financial stability and future financial goals for years to come.
How can you error-proof your divorce when it comes to finance- and money-related matters? Here are the 7 most common financial mistakes in divorce, with steps and tips for how to avoid them.
Mistake: Not Taking Time to Gather Accurate Cost of Living Expenses
Why It Happens: Some individuals rush through the divorce process and don’t take the time to put together a full picture of their cost of living expenses. “Ballparking” these amounts is a common mistake that can lead to inaccurate calculations of alimony and child support amounts. For instance, if one parent rushes and doesn’t account for all the costs associated with raising children, they may agree to lower support payments than needed. On the other hand, if one spouse mistakenly overestimates expenses, it can result in the other spouse shouldering an unfair burden. Once inaccuracies surface, it can take time, money, and frustration to fix through the courts.
How to Avoid It: Take the time to meticulously gather and document all living expenses, both for yourself and any dependents. This includes housing, utilities, food, transportation, healthcare, and education costs. For children, don’t overlook expenses like tutoring, sports fees, and other extracurricular costs, costs related to special health and/or medical needs, school transportation, and costs for summer daycare. Providing this accurate information can help secure a fair and adequate financial settlement that reflects the true needs of you and your children.
Mistake: Failing to Consider Tax Implications
Why It Happens: During divorce negotiations, people often make the mistake of focusing on immediate financial settlements without considering long-term tax consequences. For example, if one spouse takes the family home and the other takes investments, they may not consider the different tax treatments of these assets—such as capital gains taxes on sold investments or property taxes on the home. Another common oversight is not understanding how alimony and child support are taxed, which can change depending on jurisdiction and recent tax law changes. Spouses with children may not realize that decisions must be made about how the child tax credit will be applied in future years, and which spouse gets to claim it.
How to Avoid It: To steer clear of this financial mistake in divorce, work with your attorney or a tax professional to understand the tax implications of any settlement option before you agree to any terms. Consider how asset division will affect your tax bracket, the potential taxes on retirement accounts or sold assets, and the implications of alimony and child support. This foresight can help you negotiate a settlement that minimizes tax liabilities. Tip: Former spouses with children often decide to rotate the child tax credit over alternating years and include this term in their settlement.
Mistake: Ignoring Retirement Accounts + QDRO Mistakes
Why It Happens: Retirement accounts are often a substantial part of a couple’s assets, but they are sometimes overlooked or misunderstood during divorce proceedings. For instance, someone might not realize that withdrawing funds from a 401(k) or IRA before age 59½ can incur significant penalties, or that a Qualified Domestic Relations Order (QDRO) is necessary to divide these accounts without penalties. Additionally, the long-term impact of losing a portion of retirement savings can be underestimated, especially if retirement seems far off.
How to Avoid It: It’s crucial to account for all retirement and/or pension assets during divorce proceedings. Carefully look over statements and estimate the amount that is a marital asset by matching up contributions with the marriage date and the date of divorce filing. When you both agree to the terms of how to split the asset of the retirement account, a QDRO will be drawn up that states the terms of the division and when and how monies will be disbursed. This document will need to be approved by the retirement account administrator and a judge (creating a fully executed document) and then kept on file with the plan administrator.
Tip: It is important to understand that your divorce decree may state how retirement funds are to be divided, but it is the QDRO that legally seals this claim. Mistakes with QDROs are actually one of the top errors people make who opt for a DIY divorce. Often, people in a DIY divorce think they don’t need one. This is a mistake! A fully executed QDRO is not just any old agreement. It’s actually a court order that must be complied with, or you can return to court to seek enforcement of the QDRO.
Mistake: Overlooking Hidden Assets or Debts
Why It Happens: In a contentious divorce, one spouse might try to hide assets or fail to disclose debts. This can happen through transferring assets to friends or family, underreporting income, or hiding money in undisclosed accounts. Conversely, some might be unaware of debts accrued by their spouse, such as credit card debts, loans, or tax liabilities, which they might still be responsible for after divorce.
How to Avoid It: Be diligent in gathering comprehensive financial information. Does something feel off in your spouse’s financial disclosures? For example, did your spouse use Bitcoin and other cryptocurrencies in the past, but there is no declaration of a crypto account in their initial financial details? Ask for these during discovery and/or enlist the help of a forensic accountant as needed to uncover hidden crypto accounts. Also, make sure all debts are disclosed and accounted for in the divorce settlement to prevent future liabilities. Run your credit report to check for joint credit card accounts that may have flown beneath the radar.
Mistake: Emotional Decision-Making
Why It Happens: Divorce is an emotionally charged time, and decisions can be driven by emotions rather than logic. For instance, a spouse may insist on keeping the family home for sentimental reasons, without considering whether they can afford the mortgage and maintenance costs alone. Similarly, they might agree to an unfair settlement to expedite the divorce and avoid further emotional distress.
How to Avoid It: Approach decisions with a clear, rational mindset. Prioritize financial stability over emotional attachments to assets. Consulting with a lawyer and a financial advisor can provide objective perspectives and help ensure decisions are made in your long-term best interest. For added emotional support, seek the help of a divorce therapist.
Mistake: Not Updating Beneficiaries and Legal Documents
Why It Happens: After a divorce, many forget to update the beneficiaries on important documents like life insurance policies, retirement accounts, and wills. This oversight can result in unintended consequences, such as an ex-spouse inheriting assets. For example, if an ex-spouse remains the beneficiary on a life insurance policy, they may receive the payout even if the policyholder has remarried.
How to Avoid It: Review and update all legal documents and beneficiary designations as soon as the divorce is finalized. This includes wills, trusts, power of attorney, healthcare directives, and any accounts with designated beneficiaries. This ensures your assets go to the intended recipients.
Underestimating Post-Divorce Living Expenses
Why It Happens: When couples separate, they often misjudge the cost of living independently, especially if one partner previously handled most financial responsibilities. People may forget to account for new expenses such as rent, utilities, and insurance that were previously shared. For example, someone who was a stay-at-home spouse might not anticipate the full cost of healthcare premiums or the difference in utility bills between a larger family home and a smaller apartment.
How to Avoid It: To prevent this mistake, create a comprehensive budget that includes all potential expenses. This should cover not only essential costs like housing, food, and transportation but also discretionary spending, insurance, and any new expenses specific to post-divorce life. Having this information in hand can help you make major decisions like whether to keep the house or move to a more affordable place for a few years until you have your “financial sea legs” back under you.
Divorce is an important milestone in your financial story. By avoiding these common divorce financial mistakes, you can protect your financial future and reduce the stress and uncertainty that often accompany divorce. Being informed, seeking professional advice, and approaching the process with a clear, rational mindset are key steps to securing your financial well-being.
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