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How to deal with money & finances in divorce

At a glance:

The divorce process is typically a gut-wrenching ordeal, even in the most amicable of breakups. It is impossible, of course, to ignore one's emotions, but it's essential to recognize that divorce is in large measure a business transaction. The emotional trauma will fade over time, but the financial aspects of divorce will have a lifetime impact.

The importance of expert advice cannot be overstated. But it's a good idea to be familiar with a couple of major financial issues, as well as some practical matters that should inform your decision-making and lead to a better outcome. We can help you get started.

Understanding child support

Child support is a court-ordered, periodic payment following the end of a marriage or other relationship by a parent, for the financial benefit of his or her minor child(ren), or until graduation from high school (or sometimes college), whichever is later.

It is most often paid to the parent with custody of the child, but can also go to some other guardian or caregiver to the child, or to the state if the child is receiving state aid. Child support laws simply give effect to the financial obligation of both parents in raising a child.

How much is paid?

The amount of child support is based on detailed, standard guidelines set out by law. In some places, the court has authority to depart from the guidelines to achieve a more fair result in a given situation. The guidelines vary widely by state, but 20 percent to 40 percent of income is a reasonable ballpark figure, depending most heavily on the paying parent's income and the number of children he or she has to support.

The custodial parent's income, any special needs of the child, or other special circumstances can also be taken into account. A change in the paying parent's situation can trigger a review by the court and possible modification. Generally, a "material and substantial change" is required for modification. Many states have online calculators that will help you estimate how much child support you can expect to pay or receive.

What if the parents can't agree?

If the parents cannot make an amicable arrangement, the payments will be made through the court. The paying parent's wages can be garnished and tax refunds can be intercepted, if necessary. Finally, a parent who simply refuses to pay court-ordered support can even be jailed for contempt of court. Note that if you give the child or the child's other parent something directly, you will still owe the full amount of court-ordered child support. The court will likely consider what you give to the other parent to be a gift to the child. Understanding this fact will help avoid a frequent point of contention.

How is it to be used?

Child support is expected by the court to be used for the child's expenses, including food, shelter, clothing and educational needs. It is often unavoidable, however, that child support money is used in a manner that benefits the custodial parent as well. For example, it is permissible to use child support payments for rent or utilities.

Child support is not taxable to the person who receives it and not tax deductible to the person who pays it. The law assumes that if the parents lived together, after-tax dollars would be used to provide for the child, and this principle does not change merely because the parents are in different households.

Understanding alimony

Traditionally, alimony (or spousal support or maintenance) was intended to protect divorced women who did not work and were less educated from falling into poverty. According to this view, the woman's job was to raise children and run the household. Today, both spouses often work, women are much more likely to be educated and have employment potential, and it is not at all uncommon for the wife to earn more than her husband. Therefore, the question has turned to, what is fair in the 21st century?

The underlying principle of alimony is to minimize any unfair economic consequences of a divorce. Unfortunately, the standard of living of each spouse very often must drop after a divorce, since it costs more to maintain two households. The modern view is that the financial burden should be equally shared and should not discourage the less well-off spouse from working or acquiring marketable skills to enter the job market.

The law varies greatly from state to state and judges have so much individual discretion in determining the amount and duration of alimony payments that generalizations are difficult. But the trend in alimony law is to allow those paying alimony to modify the terms later if either spouse's circumstances change, especially if the recipient acquires a live-in partner.

What factors are taken into account?

In most states, the approach is that the court should exercise its discretion in common-sense fashion and take into account a variety of factors, which many states provide by law. These factors typically include:

  • The length of the marriage

  • The age of the spouses

  • The income and earning ability of both spouses and each spouse's ability to meet his or her needs independently

  • The time necessary to acquire sufficient education and training to enable the recipient-spouse to find appropriate employment, and that spouse's future earning capacity

  • The amount of marital property that was apportioned to each spouse by the divorce court

  • The contribution of each spouse to the education, earning ability, and career building of the other spouse, including the spouse's contribution to the earning of a professional degree by the other spouse

  • Whether the spouse seeking support is the custodian of a child whose age or circumstances make it inappropriate for that spouse to seek employment

  • The needs and obligations of each spouse

  • The standard of living during the marriage

  • Any pension or retirement benefits of either spouse

  • The time and expense necessary for the spouse seeking support to acquire education, training, or job experience to obtain appropriate employment

  • The lost income-producing capacity of either spouse resulting from marital responsibilities

  • The ability of the paying spouse to meet his or her own needs while meeting those of the spouse seeking support

How to negotiate alimony

Because alimony involves so many complex determinations, the court would much prefer divorcing parties to work out an arrangement between themselves. But with so many relevant factors, and so much discretion given to the judge, it's essential to have a good lawyer in alimony negotiations to make the best argument for your position.

Negotiation might be difficult, but each side should realize there is great risk in leaving the heavy lifting to a busy judge who won't be as familiar with the parties' circumstances as they and the lawyers are. The result could be an arbitrary decision leaving one or both sides unhappy they didn't resolve the matter themselves.

The need to keep planning

The stakes are high, whether you'll be paying or receiving, because the amount of alimony will have a profound effect on your planning in the years ahead. Likewise, since alimony is often not permanent, it may be necessary to plan for post-alimony life. In this regard, it is often wise to include a life insurance policy on the paying spouse's life in the negotiations, to ensure the recipient spouse gets all he or she is entitled to in the event of the payer's premature death.

Meanwhile, if at all practical, the recipient spouse should use the period of alimony to acquire education or skills to allow him or her to become self-supporting once the payments stop.

Some couples negotiate a single lump-sum payment from one spouse to the other as part of the divorce separation agreement, rather than recurring alimony payments. This has the advantage of simplicity and certainty, and avoids ongoing contact between the parties.

Note that in the nine community property states (AZ, CA, ID, LA, NE, NM, TX, WA, and WI) assets and income acquired during the marriage by either spouse will automatically be divided equally, with limited exceptions. This division can be a factor in negotiations.

Community property or not, whenever a lump sum is involved, the recipient spouse needs a sound investment strategy to ensure that the lump sum yields the same economic benefit as annual payments would have.

Tax issues of alimony

Alimony is considered unearned income. But unlike child support, alimony is tax deductible to the person who pays it, and is included in the taxable income of the person who receives it.

For welfare purposes

An alimony recipient is eligible to collect state unemployment benefits, however, as long as he or she meets the normal unemployment insurance eligibility requirements. The effect of alimony on public assistance benefits varies by state and program. Alimony income will indeed often be considered as countable income for welfare purposes, so this factor must be investigated during alimony negotiations when public assistance is an issue.

When high alimony payments are good

Note that when the spouses have widely disparate incomes, there may be some tax advantage to negotiating a higher alimony level, in exchange for lower child support. Since a husband, for example, could deduct his alimony payments, he might be able to pay his wife more than enough to compensate her for a reduced amount of child support.

Both parties could come out ahead, after taxes. Of course, detailed calculations based on your individual situation would be necessary to see whether such an arrangement made sense.

Whether alimony is negotiated or left to the court to decide, there are myriad variable factors to consider. It's imperative to get expert advice and make accurate projections as to how various alimony levels will impact your financial circumstances.

While a lawyer can help present your position clearly and persuasively, that position needs to be established first. Your attorney might not be ideally suited to handle the necessary financial issues and calculations alone, and many folks would be well-advised to seek the services of a financial planner with particular expertise in divorce planning.

What to do before your divorce is final

Talk beforehand

If at all possible, calmly exchange ideas with your spouse on how marital property should be divided prior to bringing in the lawyers. Remember that your separate property is not on the table. Separate property includes assets you owned prior to the marriage, as well as gifts and inheritances. Unfortunately, however, when money is comingled with marital funds, the separation can become problematic, as a practical matter.

What about the house?

The marital dwelling is particularly problematic. Whoever is to get the house should decide what to do—sell it or keep it. Many of us have an emotional attachment to our homes, especially divorcing parents with children still living there. But the hard reality may be that it will be impossible to afford to stay.

If that's going to be the case, better to recognize and plan for it now than later. Keep in mind, too, that upon the sale of a residence, a married couple has a capital gains tax exclusion of $500,000, while a single person can shield only $250,000 from tax.

Take care of health insurance

Don't forget about health insurance for you and the kids, if any. If only one spouse has employer-provided coverage, the divorce agreement should in most cases require that the kids remain on that spouse's policy.

As for the spouse who will soon be left uncovered, be aware of one option always available for the short term: COBRA. That's the law that allows you to stay on a divorced spouse's policy for eighteen months, although at a fairly high price. It may be a better deal to get individual coverage through a different insurer, or perhaps group coverage by joining a club or association.

Whatever the final decision, this issue should figure prominently in your settlement discussions and planning; this ought not be an afterthought.

Get your credit report

Get copies of your credit report from each of the three major credit reporting agencies. You can do this for free online at www.annualcreditreport.com. This is a convenient, one-step way to put all marital debt on the table for review and discussion. After all, dividing a couple's joint debt is a significant part of the divorce process. Moreover, it will be much easier to resolve any disputes now, rather than after the divorce.

Get separate accounts

Open individual accounts with your financial institutions (banks and brokerages). When marital assets are finally divided, these accounts will be ready to receive them. Often, too, a credit card in your name alone will be easier to get while you are still married—especially if you have a limited individual credit history.

Update your beneficiaries

Fill out new beneficiary designation forms for assets that have them—IRAs, company retirement plans and life insurance. These assets pass at death to the person named on that form—likely, your ex—regardless of what your divorce settlement or will says.

Summary of financial considerations in divorce

A key to success in life after divorce is proper financial planning before the settlement is final. Child support and alimony are the two single biggest factors in this process. Child support depends largely on each state's statutory guidelines. Alimony can be handled as a series of ongoing payments, or as a single lump sum payment made as part of the divorce settlement.

While child support and alimony are important, they are not the only issues involved, however. Health insurance, the disposition of the marital residence, and proper beneficiary designations, among others, are also items to consider in your planning.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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