Divorce is an emotional trial — but it’s also a financial one.
According to a 2012 report by the U.S. Government Accountability Office, divorce or separation led to a 41% drop in income for women and a 23% drop for men.
Though data from the Centers for Disease Control and Prevention show that the divorce rate has been trending down, most people need only look around their social circle to see that splits are still a common fate. It’s a life-changing event, but it doesn’t have to ruin your finances — or your retirement. Here’s how to protect your financial future if your knot comes untied.
Take stock of your cash flows
Having some idea of how money comes into and goes out of your bank account is always a good idea, whether a divorce is on the horizon or not. But this kind of information is especially important when you’re about to split up. You need to know not just where your money comes from — how much you partner earns and how much you earn — but also what your expenses are.
Once you have a current picture, you can go down the line and estimate how each expense will change with the divorce. Some items, like housing, may fall. Others, such as auto insurance, can rise when you’re a single buyer rather than part of a married couple.
Get creative about income
Now that you’ve taken stock of your expenses, you’ll have good insight into how much income you’ll need post-split and whether you’re looking at a shortfall. If statistics prove true, there’s likely to be a gap, so the next step is to consider how you can fill it.
People are often loath to downsize — there are so many emotional ties to your home — but it may be the best way to lower costs. Also, consider ways to earn more income in a pinch: Rent out a room, open extra space to a service like Airbnb or moonlight at the local coffee shop.
If your divorce happens when you’re on the brink of retirement age — the rate of such so-called “gray divorces” has doubled since 1990, according to the National Center for Family and Marriage Research — you may have more leeway. “You may have delayed applying for Social Security, but maybe you need to do so when you’re divorced,” says Lili Vasileff, a certified financial planner and president of Divorce and Money Matters, a financial planning company based in Connecticut. “Or maybe your investments are positioned for growth, and now they need to be positioned to generate yield.”
If possible, bide your time
There are plenty of situations in which this wouldn’t be an option, but in the case of a friendly separation, you might consider putting off the full legal split if you’re bordering on a financial milestone. Two examples Vasileff offers: Medicare eligibility at age 65 and the 10 years of marriage needed to be eligible for Social Security benefits on your ex-spouse’s record.
If you’ll lose health insurance coverage by dropping off your spouse’s insurance and you’re bumping up against Medicare eligibility, waiting can save you significant money. Medicare can be considerably cheaper than COBRA or an individual health plan.
Younger partners who aren’t close to qualifying for Medicare may still benefit from some extra time on a spouse’s health insurance, perhaps until landing a job with their own coverage.
Examine your shared retirement benefits
Marital property — a term that includes retirement assets — is divided up equally in community property states. In other states, the law may require equitable distribution, which means what it sounds like: fair, but not necessarily equal.
In either case, you may be granted a portion of your spouse’s 401(k) under a qualified domestic relations order. You’ll typically want to roll that balance into an individual retirement account to preserve its tax-deferred status. (Here’s more on how to roll a 401(k) into an IRA.)
Be sure to weigh the tax treatment of assets as you divvy them up. While $100,000 in a brokerage account sounds equal to $100,000 in a traditional IRA, the tax treatment of those accounts changes the value significantly. Because a traditional IRA holds pretax contributions, distributions will be taxed as ordinary income in retirement. A $100,000 balance could quickly turn into $80,000 or less after taxes. Money in a brokerage account, on the other hand, will carry a much lower tax burden on capital gains, interest and dividends.
Revisit your beneficiary designations
It makes the news when a big-shot mogul accidentally leaves all of his assets to a previous wife, leaving his current one in the lurch. But it happens to lower-net-worth folks, too, and it can be just as damaging to your heirs.
The beneficiaries you designate on retirement accounts and life insurance policies trump any wishes you’ve outlined in your will, which means keeping them up to date should be a top priority. Everyone should do an audit once a year or so, but it’s crucial to give everything a deeper look after a major milestone like divorce.
Updated June 22, 2017.