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Divorce Myths, Mistakes and Myopia
In the course of my divorce financial and mediation practice, I have often had clients repeat some specific piece of information they received from a well-meaning relative or friend. In general, such information should be taken with a very large grain of salt, indeed.
Some of the advice may be absolutely accurate in another state. Still other advice is outdated, perhaps based on an obsolete part of US income tax code, or is misinterpreted in such a manner as to be financially dangerous. These bits and pieces of advice often morph in the telling, gaining the stature of a new "urban myth", with people swearing that they know that their factoid is absolutely true.
Some of this information can cause the divorcing person to make some drastic mistakes that can affect them for years to come. These unpaid advisors and cheering squads, with the very best of intentions, often urge their divorcing friend or loved one into very short-sighted courses of action, with the result of damaging any future relationship with the spouse, or sacrificing their future retirement to get revenge, or for other short term purposes.
Some of the most common myths, mistakes and myopia are often easily corrected if done ahead of time and prior to the divorce being finalized or a settlement document being signed.
MYTH - Inheritances are considered to be a part of marital property
In Colorado, inherited property or that received by gift, if not commingled with marital funds, is generally considered separate property. However any gain on the inheritance during the time of the marriage may be considered to be marital property, and thus subject to division during the divorce. For example, if you inherited or brought into the marriage a brokerage account worth $50,000, unless you put your spouse's name on the account or transferred some of the funds into a joint account (or used the funds to purchase an item for the enjoyment of the spouse and family), only the gain (if any) should be subject to division during the divorce.
MYTH - IRA rollovers from one spouse to another are taxable and subject to the 10% penalty for early withdrawal
This could be true, but if done correctly, the transfer may not be taxable, and possibly, the 10% early withdrawal penalty can be avoided. For example, if the divorce decree specifies that one spouse transfer part or all of his/her IRA to the other spouse, AND the rollover occurs from the transferring IRA custodian to the spouse's receiving IRA custodian, the transfer is not a taxable event, nor is a 10% penalty invoked. A spouse receiving the IRA account may choose to take some or all of the funds in cash. If done within IRA 72T guidelines, the amount received in cash is taxable, but no 10% penalty is incurred.
MISTAKE - The value of a defined benefit pension, such as a PERA or a Civil Service Pension is the amount contributed by the employee spouse
These and other "old fashioned" pensions, are often worth far more that the contributions by the employee, and often have a cost of living adjustment for retirees. The best way to obtain the value of these kinds of pensions is to have a professional pension valuation performed. Often one spouse has a large value tied up in his or her pension, and if the pension is not divided, other assets must be used to compensate the non-pension spouse.
MISTAKE - Having fun with the divorce proceeds
Some divorcing people view the receipt of funds received as a result of divorce as a lottery winning, or as manna from heaven. They feel as if they have earned the settlement proceeds, and spend it as soon as they get it. Friends and family also may inappropriately encourage their loved one to enjoy themselves, and go ahead and spend. Taking a cruise or taking the children to Disney World may sound great, but in the long run, it often is not the best use of such funds. Until a person has a solid financial plan for utilizing the money, and has established a good financial footing, it is often unwise to spend money that can be used to build for a comfortable future.
MYOPIA - I just need extra money today I don't care about the future
Many people are so anxious to get through the divorce process that they will settle for any proposal that appears OK to them. Still others will agree to receive cash today, even if receiving part of other assets, such as IRA funds, would make more sense in the long run. Sometimes retirement funds are worth their proverbial weight in gold. They grow tax deferred, and the penalties for early withdrawal help discourage people temporarily short on cash to dip into the retirement funds. Having an IRA grow for ten, twenty or even thirty years can make a huge difference in a person's ability to retire.
MYOPIA - Keeping house as a retirement plan
One of the divorcing couple often wants to keep the house. They may be very attached to it, they may not want to uproot their children, or it might not be a good time to sell or refinance the house to buy out the other spouse. Nevertheless, keeping the house may not be the very best idea. Sometimes the house is too big, too expensive, and too difficult for the spouse to maintain. As a "retirement plan", the house is often a money pit. As it grows older, the value may not increase as much as the owner predicted. After calculating long-term maintenance and selling expenses, the person may actually have a negative balance, compared with other investments. A better approach for many would be to sell the house and buy something more affordable; as their income improves, they may be able to trade up to another house or another location, should they wish to do so.
Like many topics, a myriad of inaccurate information abounds about divorce. I have found that accurate knowledge is a divorcing persons best ally to avoiding some of the nastiest errors. Take classes, read books and articles, and work with knowledgeable and reputable experts helps people to weather this complicated and emotional time. People should always review decisions they are making to include the long-term ramifications, in addition to the short run benefits.
No-fault, which means irretrievable breakdown of the marriage, is the only grounds for dissolution. Traditional fault grounds, such as adultery, abandonment, habitual drunkenness and mental cruelty may not be used in the state of Colorado.
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