Category Archives for "Divorce Planning"

Apr 15

McKenzie Bezos: 4 Wealth Strategy Concerns

By Chris Chen CFP | Divorce Planning , Financial Planning , Tax Planning

McKenzie Bezos: 4 Wealth Strategy Concerns

source: pexels

On April 4th, it was announced that McKenzie Bezos would be receiving 36 billion dollars worth of assets from her divorce from Jeff.  

First of all, congratulations to Jeff and McKenzie for keeping this divorce process short, out of the media as much as possible, and out of the courts. We are not going to know the details of the Bezos’ agreement. However, some information has been disclosed in the press.

As reported by CNN, McKenzie is keeping 4% of their Amazon stock, worth approximately 36 billion dollars. Jeff retains voting power for her shares as well as ownership of the Washington Post and Blue Origin, their space exploration venture. According to The Economist, this makes the Bezos divorce the most expensive in history by a long shot.

As a post-divorce financial planner, I feel a little silly thinking of what I would tell McKenzie to do with her money now. The magnitude of her portfolio is well beyond run of the mill high net worth divorces with assets only in the millions or tens of millions of dollars. McKenzie can buy $100M or $200M houses and condos wherever she wants. She can have her own jets and her own yachts. She could buy an island or two.

Unsurprisingly, McKenzie’s wealth is concentrated in AMZN stock. That has worked out well for the Bezos’ for the past several years. It is likely to continue to be a great source of wealth for both of them in the future. As it stands, McKenzie is now the third richest woman in the world. Who knows, if she holds onto AMZN stock, she could become the richest woman in the world one day! McKenzie’s concerns with budgeting, taxes, and wealth strategy will soon be in a class of their own.

There are, however, some lingering considerations for McKenzie, particularly when it comes to capital gains taxes, portfolio management, philanthropy and wealth transfer.

Capital Gains Taxes

McKenzie probably has an enormous tax liability built into her AMZN holdings. While I am not privy to her cost basis, it is not unreasonable to assume that it is close to zero since the Bezos’ have owned Amazon stock since the company’s inception. Should McKenzie sell her AMZN stock, the entire amount would likely be subject to capital gains taxes. As such McKenzie may not be worth quite $36 Billion after taxes are accounted for .

A benefit of keeping the stock until her death is that her estate will benefit from a step up in cost basis. This would mean that the IRS would consider the cost of the stock to be equal to the value at her death. This favorable tax treatment would wipe out her capital gains tax liability.

Portfolio Management

Nevertheless, the standard advice that wealth strategists give clients with ordinary wealth applies to Ms. Bezos as well: it would be in McKenzie’s best financial interest to diversify her holdings. Diversifying would help her reduce the risk of having her wealth concentrated into a single stock. It is a problem that McKenzie (and Jeff) share with many employees of technology and biotech startups.

McKenzie might not want to sell all of her AMZN stock or even most of it. Although we have not read their separation agreement, she has probably agreed with Jeff that she would retain the bulk of her holding. She may also believe enough in AMZN and Jeff’s leadership to sincerely want to keep it. Regardless, McKenzie should still diversify her portfolio to protect herself against AMZN specific risks.

Philanthropy

An advantage of having more money than you need is that you have the option to use the excess to have a measurable impact on the world through philanthropy. In 2018, Jeff and McKenzie created a $2B fund, the Bezos Day One Fund, to help fight homelessness. Given that the home page of the fund now only features Jeff’s signature, this may mean that Jeff is keeping this also. McKenzie will likely organize her own charity. What will her cause be?

Philanthropy can be an effective tax and estate management tool , primarily because, within limits, the IRS allows you to deduct your donations against your income thus helping you manage current and future taxes. For McKenzie, it is about deciding what to do with the money, instead of letting Congress decide.

Wealth Transfer

McKenzie’s net worth is far in excess of the current limits of federal and state estate taxes. Unless she previously planned for it during her marriage, she will have to revise her estate plan.  Even though she would benefit from a step up in basis on her AMZN stock if she chooses not to diversify, she would still be subject to estate taxes, potentially in the billions of dollars.

Of course, no matter how much estate tax McKenzie ends up paying, it is likely that she will have plenty to leave to her heirs.

Financially, McKenzie Bezos has what wealth strategists would consider as ‘good financial problems’ . She has the financial freedom to focus on the important aspects of life: family, relationships and making a difference.

 

A version of this post appeared in Kiplinger on April 12, 2019

Jul 19

Post-Divorce Investments – What do I need to plan for now?

By Eric Weigel | Divorce Planning , Investment Planning , Portfolio Construction , Risk Management

Making Your Post-Divorce Portfolio Reflect the New You

Divorce is the final step of a long process. Whether the marriage was long or short, the end of marriage brings about the conclusion of an important phase of your life.

Divorce is an emotional event sometimes anticipated years in advance and at other times coming totally out the blue.

In all cases whether anticipated or not, divorce is a stressful event. According to the Holmes-Rahe Life Stress Inventory Scale divorce ranks as the second most stressful event that a person can experience in a lifetime.

Typically when you divorce you end up with an investment portfolio that is ½ of your old couple’s portfolios. Invariably, your new portfolio will not be suitable anymore.  If you haven’t been the “financial” person in your marriage you may not even know what you own.

Most likely you will need to make changes to your portfolio to suit your new situation. You are now also solely responsible for your financial health.

Your post-divorce portfolio should reflect your updated needs, objectives and comfort level with investment risk.  This may not be what you bargained for or you may feel ill-prepared to handle this on your own.  You may feel that your life is out of your sync, but aligning your financial assets to your new situation is entirely under your control.

Why do you need a new portfolio once you divorce?

For one, the dollar amounts are less than before and your current investment strategy reflects your goals as a couple rather than your own objectives going forward.

Moreover, most likely your confidence is a bit shot and your desire to take much investment risk is lower than before.

Ok, are you with me? You can control this aspect of your new life. What steps should you take to get the ball rolling?

We suggest an approach rooted in our P.R.O.A.C.T.I.V.E methodology.

The first step involves thoroughly examining your new situation from a non-financial standpoint.  Where do you want to live? What type of lifestyle are you looking for? If you have children what type of issues do you need to account for?

The second step is to re-evaluate your comfort with taking investment risk.  Now that you are solely in charge of your financial life how do you feel about taking on risk? Are you comfortable with the inevitable stock market swoons that occur periodically? Are you able to think as a long-term investor given your recent divorce?

The next step is really important. Your post-divorce portfolio needs to work for you. Establishing a hierarchy of financial objectives will drive the type of strategy that is most appropriate for you.

Is your primary objective to save for retirement? Do you have any major objectives besides retirement? Maybe you need to fund college tuition for your two kids.  Maybe you plan on buying a new home in 2 years once your life has settled down?

Next you need to deal with the nitty gritty of figuring out exactly what you own and cash flow budgeting.  What you own should not be difficult to figure out as you have just gone through the divorce process.

The second part of cash flow budgeting is often highly sensitive for people not used to budgeting during their marriage.  If you have never had a budget or stuck to one this step seems like a major imposition. But unless money is so plentiful you have no choice.

At least for a period of time you will have to keep track of your expenses and gain an understanding of where the money is going. The reason this is important is that you may need to tap into portfolio gains to fund your living expenses. If that is the case, your portfolio should be structured to write you a monthly check with a minimal amount of risk and tax consequences.

The next step in the P.R.O.A.C.T.I.V.E process is to evaluate your tax situation. If you are in a high tax bracket you might want to favor tax-advantaged investments such as municipal bonds. If your income is going to be taking a hit post-divorce you probably will end up in a lower tax bracket increasing the attractiveness of a Roth conversion to your traditional individual retirement account.

The last three steps all involve figuring out how best to construct your investment portfolio.  Going from your pre-divorce portfolio to something that fits your needs and goals will usually require some major re-adjustments in your strategy.

Going through our P.R.O.A.C.T.I.V.E process or a similar approach is probably the last thing you want to do on your own.  Most likely you will need the help of an advisor to work through this.

Keep in mind that the reason you are doing this is to regain control over your financial life. You sought the help of a lawyer during your divorce. Now is the time to move forward and seek the help of financial professionals with an understanding of your situation and new set of needs.

What is the best way to implement a portfolio strategy for newly divorced people?

The most important aspect of post-divorce portfolio is that it fits you and your new circumstances and desires.  Using our P.R.O.A.C.T.I.V.E methodology as a framework for evaluating your needs and desires we suggest implementing a portfolio structure that encompasses three “buckets”.

A “bucket” is simply a separate portfolio and strategy that has a very specific risk and return objective. Each bucket in our approach is designed to give you comfort and clarity about its role in your overall portfolio.

What is the role of these “buckets”?

Each “bucket” has a very specific role in the overall portfolio as well as very explicit risk and reward limits.

We label our three “buckets” as the Safe, the Purchasing Power and the Growth portfolios.

The role of the Safe Bucket is to provide liquidity and cash flow to you to meet your short-term lifestyle needs. How much you have invested in your Safe portfolio is a function of how much money you need to fund your lifestyle over the next few years.

The second bucket – the Purchasing Power portfolio – is designed to allow you to enhance your lifestyle in terms of real purchasing power.  What this means is that every year your portfolio should have a return exceeding inflation.

Finally, the third bucket – the Growth portfolio – is designed to grow your portfolio in real terms. This portfolio is designed to maximize your returns from capital markets and will be almost exclusively invested in higher risk/higher reward equity securities.

Conclusion:

Going through divorce is one of the most stressful situations anyone can face. Transitioning to a new beginning may take a short term for some but for most people the period of adjustment is fraught with uncertainty and doubt.

People often worry about their finances and whether they can maintain their lifestyle.  A life event such as divorce also tends to shorten people’s horizon as their outlook in life often lacks clarity.

The implications from an investment standpoint are primarily a temporarily diminished desire to take on portfolio risk and a shortening of time horizons.  In English this translates to searching for greater certainty and not looking too far out.

As wealth managers our first goal is to first understand the client’s circumstances and needs once the divorce is finalized. Our P.R.O.AC.T.I.V.E process serves as the framework for initiating and exploring client concerns and issues.

Our P.R.O.A.C.T.I.V.E approach is designed to make your money work for what you deem important.  Divorce is difficult and transitioning to a new beginning takes time.  As you adjust to your post-divorce life your financial assets will also need to be managed consistent with the new you.

At Insight Financial we are experts at guiding you through this difficult adjustment period and transition into a new beginning. To read our full report on our approach for managing your post-divorce investments please click here.

Our wealth management team at Insight Financial Strategists is ready to help you in your transition.  To set up an initial consultation please book an appointment here.

 

Other posts you may find interesting

Pension Division in Divorce

4 Risks of Pension Plans in Divorce

Post-Divorce Investments 

 

 

Jun 15

4 Risks of Pension Plans in Divorce

By Chris Chen CFP | Divorce Planning , Financial Planning , Retirement Planning

4 Risks of Pension Plans in Divorce

Although the number of pension plans has significantly declined over the years there are still many of them out there, and many divorcing couples have to figure out how to deal with them. The prime benefit that a pension plan provides is a fixed lifetime income.  A stream of income in retirement could well be a pension synonym. It used to be that fixed income was considered a negative. However, nowadays it is the lucky retiree who benefits from a pension plan!

In case of divorce, issues surrounding who is entitled to the pension present a challenge especially in the case of grey divorces (usually defined as people over 50).  Divorce and pension plans can sometimes generate conflict as the owner of the asset will often feel more proprietary about it than with other assets. Employees are often emotionally vested in their pension. They feel, more than with other assets, that they have really earned it. And that their spouse has not.  They often will have stayed in a job that they may not have liked for the privilege of qualifying for a higher paying pension. Couples look forward to getting that income when they retire. And so spouses will want to make sure that they get their share of it as part of the divorce.

Pension rights after divorce are determined as part of the overall divorce process. In a negotiated divorce, the parties can decide, within limits, how to divide their assets. In the worst case, the courts will make the decision.

What is a pension plan and how does it work?

The value of a pension benefit can be difficult to determine. Unlike other accounts, pensions don’t come with a statement that makes them easily comparable to other assets; they come with the promise of a benefit (the monthly payment that someone might get at retirement). So the number one priority when a pension is involved in a divorce is to get a valuation. The financial consequences of divorce are serious, and not getting a valuation may lead to struggling financially after divorce

Risk of Valuation

Even when valued, the number provided on a report may lead to a false sense of security. Unlike other retirement statements, the value of a pension is estimated using the parameters of the beneficiary and of the pension. In most cases the divorce pension payout is calculated with a predetermined formula based on the employee’s length of employment and income.  In some cases, the benefit may vary depending on a few other factors.

The next step is to estimate how long the benefit might be paid. That is done using actuarial tables. Based on periodic demographic studies, actuarial tables predict our life expectancy. Some actuarial tables include those produced by the Society of Actuaries, the Internal Revenue Service, and the Pension Benefit Guaranty Corporation (PBGC). A pension valuation will normally use the estimates from the actuarial tables representing  an average life expectancy of a cohort of people born in the same year. The estimates are usually accurate within their parameters, as individual variability is smoothed out  for large populations. However, individual longevity is harder to predict as it may fall within a wider range.

With the amount of the payment and the length of time that the payments will be made, how much is all of that worth?   Pension valuators use a “discount rate” to approximate the value of a future payment. The principle is that the value of a dollar paid next year will be less than the value of a dollar paid today. Hence you should be willing to accept less than a dollar for the promise of a payment next year, and even less for the promise of payment the year after.  

Financial analysts will use the concept of the prudent rate of return, the rate that a prudent person would invest at in order to receive that dollar next year or beyond. That of course could be subject to interpretation. Often the standard that is used is the government bond rate for the duration of the payment.  US government bonds are often considered to be risk free by economists and the public, although that too is subject to debate (Currently US government debt is rated at AA+ (below AAA) by Standard & Poor’s, the leading debt rating agency). Nonetheless that rate is often used for individual pension valuations.

The PBGC, on the other hand, has developed its own rates. The PBGC uses different rates before retirement, and rates during retirement. The former are significantly higher than the latter and assumes a rate of return that is in excess of the risk free rate.  That may be a better model for actual human behavior, as people will normally be tempted to take more risk for a better return, rationalizing, of course, that the incremental risk is not significant. On the other hand, for rates during retirement the PBGC uses rates that are well below the norm, reflecting the reality that retirees are even more risk averse than the average population.

Financial analysts will determine the value of the pension by taking a present value of the pension payments over the expected longevity of the individual at the determined discount rate(s). The number that comes out is usually a single number assuming a date of retirement.  

Understanding that we are working with an estimate, people usually ignore the fact that the magic number does not take into account the likely variability of  the inputs, in particular longevity.

If you will be the alternate payee (ie, if you are the spouse aiming to get a share of the other’s pension), it is important to pay attention to the fact that the real value of your share of the pension will fall within a range. It will not be a single number Hence when you trade that pension for another asset that has a fixed value, you want to make sure that you are not short changing yourself.

On the other hand if you are the beneficiary of the pension, it is painful enough to give up a share of it.  You don’t want to give up part of that asset if it will not be fully used. If it is the alternate payee that passes away early, his or her stream of payments stops, and, in most cases, does not revert back to you, the initial beneficiary.  If that were to happen you will have wasted a potentially substantial asset.

In summary it is important for divorcing couples to fully understand the value of their pensions for themselves and for their spouse.  Divorce already destroys enough wealth. There is no need to destroy more.

Risk of Default

Pensions have a risk of default or reduced benefits in the future. According to the Society for Human Resources Management  114 pension funds are expected to fail in the next 20 years. That is true even for pensions that do not look like they are in trouble currently. Some people may think that this is farfetched. Yet you only have to look at the Pensions Right website to convince yourself that benefit reductions do happen. When you consider that retirement can last 20, 30 or 40 years, you will want to evaluate if your pension plan is robust enough to last that long, and continue making payments for that long.

The risk of benefit reductions or outright default may apply mostly to the private sector. Yet public sector plans may be at risk also. For instance, Social Security has a trust fund that, together with payroll deductions, funds its retirement benefits (social security retirement benefits are effectively a pension). According to the 2009 Social Security Trustees Report, the Social Security trust fund will run out in 2037. When that happens, the Trustees project that retirement benefits will be cut by 24%.  

It should be noted that Social Security benefits are not divisible in divorce  The beneficiary keeps his or her benefits. The ex-spouse can get 50% of the beneficiary’s benefits (if married 10 years or longer) or 100% of his or her own, whichever is higher, but not both. That happens without prejudice to the prime beneficiary.

However, in 2037, both parties can expect a Social Security retirement benefit cut of 24%, unless Congress remedies the situation beforehand.

Personal Risk

People also underestimate personal risk. If you receive a pension as an alternate payee (ie the spouse who is getting a share of the pension from the former employee), you will want to consider the risks that your payments may be interrupted due to issues with your ex-spouse. Many pensions stop spousal payments when the beneficiary passes. When that happens, the alternate payee will have to find an alternate source of income to compensate.

It is worth remembering that our life expectancies are random within a range. The expected longevity of women reaching 65 years of age is to 85 years of age.  We often anchor on this or other numbers forgetting that few women pass away at 85. Most will pass away either before 85 or after 85. According to a paper by Dr. Ryan Edwards for the National Bureau of Economic Research, the standard deviation for longevity is 15 years. That means that most women will live to 85, +/- 15 years. From 70 to 100 with an average of 85. That is a wide range! What if the beneficiary of the pension passes away 10 years before his her life expectancy, and the alternate payee lives 10 years longer than life expectancy? That means that the alternate payee may have to do without his or her share of the pension for 20 years or longer (if the two ex spouses have the same expected longevity).

And what about inflation risk?

Most pensions do not have a Cost of Living Adjustment (COLA). That does not apply to all of them. For instance, the Federal Employee Retirement Systems (FERS) has a limited COLA. Effectively, when there is no inflation adjustment, the value of a pension payment is reduced every year by the amount of inflation. How bad can that be, you ask? Assuming a 3% inflation rate the value of a fixed payment will decrease by almost 50% over 20 years.  . What is the likelihood that expenses will have reduced by 50%?

A Last word

Pensions are a very emotional subjects in divorce. Perhaps because we are naturally risk averse, and perhaps because our risk aversion is exasperated by divorce related anxiety, we like to cling to what we perceive as solid. People will often want to keep the marital home, even if they cannot afford it, or take a chunk of a pension even when it may make better sense to trade it for another asset. Worse yet they will want to know whether to keep the house or pension in divorce.

What other asset you may ask? You could trade the pension for a tax- deferred retirement asset, such as an IRA or a 401k.  Or any other asset that you and your spouse own. The right decision will end up being different for everyone.

As a Divorce Financial Planner, it is my task to make sure that each side understands exactly what is at stake, and to help prepare them for rebuilding financially after divorce. In many cases it makes sense for both parties to get a share of the pension. In others it does not.  How to keep your pension in a divorce is a vital question. Even more important is to understand the true value of the pension, and its ambiguities.  It is a difficult task in a process that is already filled with anxieties and uncertainties to focus effectively on yet one more ambiguity. Yet for successfully managing finances after divorce it must be done.

 

Other posts that you may find interesting:

Pension Division in Divorce

Post-Divorce Investments 

In Divorce, Can We Share a CDFA?

 

 

Nov 10

Killing Alimony

By Chris Chen CFP | Divorce Planning , Financial Planning , Tax Planning

Killing Alimony?

Eliminating the deductibility of alimony payments from taxable income is one of the features of the Republican House Tax Reform bill. It is very significant to both payors and recipients of alimony.

The Goddess Nemesis

Written into the fabric of the GOP tax proposal is a change in how alimony is taxed. People paying alimony could lose “the greatest tax deduction ever.” And that could ultimately affect those receiving alimony, too.

Since details of the new tax overhaul bill were released on Nov. 2, people of all income levels and ages have been trying to figure out how they could be affected going forward. One group of folks not likely to be happy: those paying alimony.

Section 1309 of the House bill would eliminate the deductibility of alimony. Killing the alimony deduction is one of the smaller revenue targets for the House Republican tax bill, yet it is exceedingly significant to the people affected.

Under current rules, alimony payors may deduct their payments from their taxable incomes, thus lowering their income taxes. In return, recipients pay income taxes on their alimony income. Because payors are usually in higher tax brackets and recipients in lower tax brackets, families can save money on taxes by shifting the tax burden to the lower earner. The saving can help increase cash flow for divorcing couples. They can then decide how to allocate the savings: to the payor or the recipient … or the court can do it for them.

Killing the alimony tax deduction raises only about $8 billion over 10 years

According to the House, abolishing the alimony deduction would not be a large revenue generator. By killing the alimony tax deduction, the alimony tax bill raises only about $8 billion over 10 years. That is because the tax increase on payors is offset by a tax decrease for recipients. For them, alimony income would no longer be taxable.

This wrinkle could have a significant impact on divorce settlements. For many payors, saving taxes on alimony payments is the one pain relief that comes with making the payments. According to John Fiske, a prominent mediator and family law attorney, “Alimony is the greatest tax deduction ever.” Without the deduction, payors will find it much more expensive and more difficult to agree to pay.

For example, in Massachusetts alimony payors usually pay 30% to 35% of the difference in the parties’ incomes. For a payor in the 33% federal tax bracket, the House tax bill increases the cost of alimony by nearly 50%.

The entire set of laws, guidelines and practices around alimony are based on its deductibility. Passage of the House Republican tax bill is likely to lead to a mad scramble in the states to change the laws and guidelines to adjust alimony payments downward to make up for the tax status change.

The likely net result: although recipients would no longer pay tax on alimony income, abolishing the tax deductibility of alimony is likely to reduce their incomes even further as divorce negotiations take the new, higher tax burden on payors into account.

A previous version appeared in Kiplinger

Jan 17

Five Common Questions About Divorce

By Chris Chen CFP | Divorce Planning , Financial Planning , Retirement Planning

divorcing-swansdivorcing-swans5 Common Questions About Retirement and Divorce

divorce and retirementRetirement accounts are often one of the major assets of divorcing couples. Analyzing and dividing retirement accounts can be fairly complex . Some of the major questions that I come across include the following:

1. Is My Retirement Account Separate Property?

People will often feel very proprietary about their retirement accounts. They will reason that because the account is in their name only, as opposed to the house which is usually in both their names, they should be able to keep those accounts. Most of the time, this is flawed reasoning. The general rule is that assets that are accumulated during marriage are considered marital assets regardless of the titling.

However, there are cases when part of a retirement plan can be considered separate. This often depends on state law, so it is best to check with a specialist before getting your hopes up.

2. Can I Divide a Retirement Account Without Triggering Taxes?

Most of us know that taking money out of a retirement account will usually trigger taxes and sometimes penalties. However, dividing retirement accounts in divorce provides an exception to that rule. You can divide most retirement accounts in divorce tax-free through a Qualified Domestic Relations Order  (QDRO). As a result of the QDRO, both spouses will now have a separate retirement account.

QDROs are used for 401(k)s, defined benefit pension plans, and other accounts that are “qualified” under ERISA . Many accounts that are not “qualified” such as 403(b)s use a “DRO” instead. The federal government uses its own procedure known as a “COAP”. Some accounts such as IRAs and Roth IRAs can be divided with a divorce agreement without requiring a QDRO.

Since there are so many different retirement accounts, the rules to divide them vary widely. Plan administrators will often recommend their own “model” QDRO. It usually makes sense to have a QDRO specialist verify that the document conforms to your interests.

3. Can I Take Money out Without Penalty?

In general, you cannot take money out of retirement accounts before 59½ years of age without triggering income taxes and a 10% penalty . It makes taking money out of retirement accounts a very expensive proposition as you may only get 60 to 70 cents for every dollar that you withdraw, depending on your tax bracket and the State that you live in.

In addition, that money that was set aside for retirement will no longer be there for that purpose. Although you might tell yourself that you will replace that money when you can, that rarely ever happens.

However, if you have no other choice, it so happens that divorce is one of the few exceptions to the penalty rule. A beneficiary of a QDRO (but not the original owner) can, pursuant to a divorce, take money out of a 401(k) without having to pay penalties. However, you will still have to pay income tax on your withdrawal. Note that this only applies to 401(k)s. It does not apply to IRAs.

4. How Do I Compare Retirement Accounts with Non-Retirement Accounts?

Most retirement accounts contain tax-deferred money. This means that when you get a distribution, it will be taxable as ordinary income. At the other end of the spectrum, if you have a cash account, it is usually all after-tax money. In between you may have annuity accounts where the gains are taxed as income, and the basis is not taxed; you may have a brokerage account where your gains may be taxed at long-term capital gains rate; or you may have employee Restricted Stock which is taxed as ordinary income. All of these accounts can be confusing.

In order to get an accurate comparable value of your various assets, you will want to adjust their value to make sure that it takes the built-in tax liability into account. Many divorce lawyers will use rules of thumb to equalize pre-tax and after-tax accounts. Rules of thumbs can be useful for back-of-the-envelopes calculations , but should not be used for divorce settlement calculations, as they are rarely correct.

What is the harm you might ask? Rules of thumb are like the time on a broken clock – occasionally correct, but usually wrong . In the best of cases, they may favor you. In the worst cases they will short change you. If the rule of thumb is suggested by your spouse’s lawyer, it will have a good chance of being the latter.

Because these calculations are not usually within a lawyer’s skill set, many lawyers and clients will use the services of a Divorce Financial Planner to get accurate calculations that can form a solid basis for negotiation and decision making. It is usually better to know than to guess .

5. Should I Request a QDRO of My Spouse’s Defined Benefit Pension?

Defined Benefit pension plans provide a right to a stream of income at retirement . Unlike 401(k)s and IRAs they are not individual accounts. They do not provide an individual statement with a balance that can be divided.

As a result, many lawyers take the path of least resistance and will want to QDRO the pension. It is usually painful to the pension beneficiary who will often feel very emotional about his or her pension. And it is not necessarily in the spouse’s interest to QDRO the pension .

A better approach is to consider the value of the defined benefit pension compared to the other retirement assets. With a pension valuation, you can judge the value of the pension relative to other assets and make better decisions on whether and how to divide it. A pension valuation will allow each party to make an informed decision and eventually provide informed consent when agreeing to a division of retirement assets.

Another key consideration is that defined benefit plans are complex. Although they have common features, they are each different from one another, and each come with specific rules. You will be well advised to read the “plan document” or have a Divorce Financial Planner read it and let you know the key provisions.

A common provision is that the benefit for the alternate payee can only start when the plan participant starts receiving benefits and must stop when the plan participant passes away. It is all good for the plan participant. But what if as a result of that, the alternate payee ends up losing his or her pension benefits too early?

Hence a key issue of valuing defined benefit plans is that a true valuation is more than just numbers. It also involves a qualitative discussion of the value of the plan, especially for the alternate payee. Some Divorce Financial Planners can handle the valuation of interests in a defined benefit plan easily and the discussion of the plan. Others will refer you to a specialist.

The Bottom Line

Retirement plans are more complex than most divorcing couples expect . Unlike cash accounts they do not lend themselves to a quick asset division decision.  The short and long-term consequences of a sub-optimal decision can be far reaching. It will be worth your while to do a thorough analysis before accepting any retirement asset division.

 

 

A previous version of this post was published in Investopedia

Jul 19

Getting Help When You Need It Most

By Chris Chen CFP | Divorce Planning , Financial Planning

Getting help when you need it most

chess pieces divorcingWhen “Lindy” was trying to figure out the implications of the latest divorce settlement offer that she received from her soon-to-be ex-husband “Ted,” she panicked. She would have asked her lawyer for
guidance, as 79% of divorcing individuals end up doing, but she was not sure that her divorce lawyer could give her the guidance she needed .

The previous offer had come two days before their last court appearance. There was just not enough time to understand the implications of the various components of the offer and assess whether it was an equitable division of marital assets. Lindy was just too nervous to make the decision “on the steps of the courthouse”, so she said no.

Even Lindy’s lawyer was happy with the process

Clearly, there is something wrong with a process in which the financial outcome is so critical to both parties but people like Lindy and Ted get no professional financial support despite spending substantial sums of money litigating a divorce. Yet it is not surprising. The financial issues of divorce have become terribly complex ranging from shorter-term tax issues to longer-term financial planning issues.  Divorce lawyers have enough on their hands with the legal issues of divorce. Increasingly, divorce lawyers are unable to counsel their clients in depth on the financial implications of divorce , which inevitably have a lasting impact on their quality of life and stability long after the divorce itself is finalized.

According to a recent survey conducted by the Institute of Divorce Financial Analysts, 75% of respondents believe that a divorce financial specialist would have been helpful in the preparation, negotiation or recovery phases of their divorces . According to this same survey, 45% of people litigating their divorces felt unprepared to enter financial negotiations and 40% of those mediating their divorces feel the same way.

No wonder divorce financial planning has risen as a specialty. Professionals dedicated to meeting the needs of divorcing individuals can help people such as Lindy and Ted understand the financial issues of divorce, negotiate settlements and recover into a financially stable post-divorce life.

In Lindy’s case, she was fortunate to be referred to a Divorce Financial Planner by a divorce coach. Divorce Financial Planners build on financial expertise often acquired by Certified Financial Planners (CFP®) or Certified Public Accountants (CPAs). They also often hold the Certified Divorce Financial Analyst (CDFA®) designation. They excel in their ability to simplify the complex financial issues of divorce so that people like Lindy and Ted can understand the consequences of their decisions and plan accordingly for their separate futures. In addition, Divorce Financial Planners bring to the table an understanding of tax issues in divorce, employee stock options, retirement plans, pension plans, Social Security, real estate and long-term financial planning.

They help assess potential outcomes of strategies such as trading home equity for ownership of retirement accounts—is that a good idea for you for the long term?

In Lindy’s case, the new offer seemed to address her needs better. Ted offered to give Lindy more of the 401(k) in exchange for keeping his pension. In addition, Ted offered more alimony.

However, Ted’s offer was still not clear about his employee stock options, as he did not know how to value them. In addition, the offer did not address the issue of college funding for their 13 year old daughter.

Lindy’s Divorce Financial Planner carefully reviewed the settlement offer in light of her individual circumstances, explained the various issues and made recommendations for her lawyer. After some more negotiations, Lindy and Ted were able to come to an agreement and avoid a costly trial. Even Lindy’s lawyer was happy with the process , as it helped him to focus on his area of expertise: writing the agreement and managing the legal process.

A previous version of this post was published in Kiplinger

Jun 13

Alimony…not far from Acrimony

By Thomas Seder | Divorce Planning , Financial Planning

Alimony...not far from Acrimony

Alimony issuesA major issue between divorcing and divorced spouses is that of spousal support, or alimony.  The issue is freighted with significant financial and emotional ramifications.  The aim of spousal support is to provide needed economic support to the lower-earning spouse.  It takes into account a variety of factors, including length of the marriage, ages and health of the parties, earning capacity, assets of the parties, needs of the recipient, and the payor’s ability to pay.

In 2011 the alimony laws in Massachusetts underwent significant reform .  Prior to this enactment of alimony reform, alimony was “forever”, even for short-term marriages.  Under the old laws, retirement of the payor didn’t necessarily provide relief from the payor’s having to continue support payments indefinitely.  You can get a summary of the new law here.

Not surprisingly, there are countless horror stories regarding alimony and how it has contributed to financial and emotional ruin.  The Alimony Reform Act of 2011, which took effect in March 2012, was intended  to bring more fairness to the alimony calculation and is highlighted by the following:

(1) it ends payments for life;

(2) it ties the duration for paying alimony to the length of the marriage;

(3) for long term marriages (more than 20 years), alimony ends at Full Retirement Age , as defined by Social Security (though the judge has discretion in awarding indefinite alimony in long-term marriages); and

(4) alimony may be terminated, reduced, or suspended when the recipient spouse lives with another person for at least three months (the “cohabitation” issue).  

To get your comprehensive summary of the Massachusetts Alimony Reform Law click here.

One conclusion gleaned from the legislation’s focus on limiting the duration of alimony is that it becomes more critical for the lower-earning spouse to find employment, in order to be self-sufficient when alimony ends.  

Child support in many ways is tied to alimony .  For example, in cases where the combined incomes of divorcing spouses is above $250,000, there may be no alimony granted…the only form of support may be child support.  Also, depending on the respective tax brackets of the divorcing parties, it may sometimes be beneficial to both to consider using “Unallocated Support”, which is essentially re-characterizing child support as alimony.

While Alimony Reform does much to clarify certain issues, there still remains room for interpretation, and different judges may adopt very different positions on the same fact patterns…one should bear in mind that nothing is etched in stone.  Nonetheless, familiarity with these guidelines should help to point you in the right direction on the subject of alimony.  The issues are complicated and intertwined and should be reviewed with an attorney, or divorce financial planner.  However, to start our handy reference may suffice!

Sep 29

Pension Division in Divorce

By Chris Chen CFP | Divorce Planning , Financial Planning , Retirement Planning

 

Pension Division in Divorce

Pension Division

Themis, Goddess of Justice

Jenni (specifics details have been changed) came to our office for post-divorce financial planning. Jenni is 60, a former stay-at-home Mom and current yoga instructor with two grown children. She never had a professional career and spent much of her adult life with a series of low-paying part-time jobs. She is thinking about retiring now and wanted to know whether she would be able to make it through retirement without running out of assets.

Jenni traded her interests in her husband’s 401(k) in exchange for the marital home, an IRA and half of a brokerage account . The lawyers agreed that the 401(k) should be discounted by 25% to take into account the fact that a 401(k) holds pretax assets.

Adjustments to the Value of a 401k

That sounds reasonable on the surface. But as a professional financial planner, I believe that it was a mistake for Jenni to agree to a 25% discount adjustment to the 401(k). After analyzing her finances, it became clear that Jenni would likely always be in a lower-than-25% federal tax bracket after retirement. Had she met a Divorce Financial Planner sooner, he or she would have likely advised against agreeing to a 25% discount to the value of the 401(k).

Jenni and Ron, her ex-husband, also agreed that she would get half of her marital interest in a defined-benefit pension from his job as a pediatrician with a large hospital.  At the time that pension division was agreed to, Ron thought that there was no value to the pension, and it was probably “not worth much anyway.” Neither lawyer disagreed.

[A Pension does] not come with a dollar balance on a statement

This underscores the importance of seeking the advice of the right divorce professional to analyze financial issues!  Working in a team with mediators and divorce lawyers, divorce financial planners usually pay for themselves .

After a little research I found that Jenni would end up receiving a little over $37,000 a year from the pension division at Ron’s retirement, assuming he is still alive then. This is far from an insignificant sum for a retiree with a projected lifestyle requirement of less than $5,000 a month!

There are also restrictions with dividing Ron’s defined-benefit pension: the ex-spouse or alternate payee (Jenni in this case) can get his or her share only when the employee takes retirement. Furthermore, the payments stop when the employee passes away. (Each defined-benefit pension has its own rules . Each defined benefit pension division should be evaluated individually ).

The Value of  Pension Division Analysis

A defined-benefit pension such as this one does not have a straightforward value in the same way as a 401(k). It does not come with a dollar balance on a statement. A pension is a promise by the employer to pay the employee a certain amount of money in retirement based on a specific formula . In order to get a value and for it to be fairly considered in the overall asset division, it needs to be valued by a professional.

In her case, Jenni’s share of the pension division was 50% of the marital portion of the defined-benefit pension. Was it the best outcome for Jenni? It is hard to re-evaluate a case after the fact. However, had she and Ron known the value of the pension, they might have decided for a different pension division that may have better served their respective interests. Jenni may have decided that she wanted more of the 401(k), and Ron may have decided that he wanted more of the pension. Or possibly Jenni may have considered taking a lump-sum buyout of her claim to Ron’s pension . In any case, they would have been able to make decisions with their eyes open, instead of taking the path of least resistance.

The news that her share in Ron’s defined benefit pension had value was serendipity for Jenni. It turned out that the addition of the pension payments in her retirement profile substantially increased her chances to make it through retirement without running out of assets. But it is possible that an earlier understanding of the pension division and other financial issues could have resulted in an even more favorable outcome for Jenni .

 

A previous version of this article was published at Kiplinger.

May 27

Steps to a Divorce Diagnostic

By Chris Chen CFP | Divorce Planning

Steps to a Divorce Diagnostic

Divorce DiagnosticPeople who are contemplating divorce are often overwhelmed with the process. That’s completely normal. After all divorce is not something that you do every day.

As a Divorce Financial Planner and Wealth Strategist, I work with women and men who are contemplating divorce, going through divorce or recovering from divorce. Every one of these men and women are going through significant upheaval in their lives. They all need a Divorce Diagnostic .

So, where should you begin?

As a Divorce Financial Planner, it should come as no surprise that I would advise you to deal with your finances first and get a Divorce Diagnostic . There is an old saying that marriage is about love, and divorce is about money. This is not entirely true. Divorce is an emotionally draining process that is about a lot more than money. Yet in the end, whether it is the amount of assets you will get, the child support you will pay or the legal retainer you will pay, it often comes down to the money.

After a divorce there will usually be a lot less money with which you will now have to run your households. You will have to consider the tax and cash flow consequences of keeping or selling the marital home. You may need to reconsider your retirement planning. The list is long.

However, there are seven steps that you can take before you start your divorce process leading to a Divorce Diagnostic ™ that may make the process less painful.

1. Take an inventory of all your financial records.

As a first order of business, you need to gather all financial records of both you and your spouse, including bank account information, tax returns, mortgage statements, credit card bills, wills, trusts, life insurance policies and retirement accounts, to name a few. Be especially mindful of assets either of you believes have no value or indeterminate value, such as employee stock options, unqualified executive compensation plans and defined benefit pensions. Disputes often center around specific assets. It is important to know what they are and where they are.

2. Open new bank and credit accounts in your own name.

You should have your own source of funds. Open a checking account in your own name, preferably at a different bank from where you hold your joint account. If you do not have a credit card in your own name (not a joint credit card), get one. If you have no income of your own that may be difficult. Before you open your checking account, you may want to verify that the bank will give you a credit card also.

3. Monitor your credit report.

This is a good way to keep a pulse on how your financial situation will be evolving until you divorce. The credit reporting companies allow you a free copy every year. You should take advantage of this offer.

4. Start budgeting for legal and professional fees.

Divorce is expensive. You will likely require the help of professionals including lawyers, mediators, divorce financial planners and mental health professionals. Make sure that you have funds available for these expenses.

5. Consider alternatives to litigation.

Explore options such as mediation or a collaborative divorce. If you have reasonably good communication with your spouse, these alternatives may be quite a bit less expensive than the traditional litigation model. The goal is to get through divorce intact, not to spend all your assets on legal fees.

6. Assemble a team.

Not unlike a sports team, each player has a role. You will need a family lawyer to review the legal aspects of your divorce. You may need a therapist to help you deal with the emotional rollercoaster. You and your spouse may decide to use a mediator. And you will need a Divorce Financial Planner to help you with the financial aspects of divorce.

7. Conduct a Divorce Diagnostic ™.

A Divorce Diagnostic ™ will allow you to get a good grasp of your financial situation, and likely outcomes, right at the beginning of the process. You will then be able to plan accordingly and make sound decisions on how to move forward. Gaining control of the process before it gets control of you will allow you to best achieve a favorable outcome.

Divorce is a lot of work that can seem daunting. Completing these seven steps will help you feel more in control and better equipped to make thoughtful, reasoned decisions.

You want to come out of divorce in the best financial and emotional shape possible, with the well-being of your children protected, your assets preserved and a sound long-term financial plan in place.
(A previous version of this post was published in the Boston Globe)

May 30

The IRS thinks you are cheating on your Spousal Support

By Chris Chen CFP | Divorce Planning , Financial Planning

 

The IRS thinks you are cheating on your spousal support

Spousal SupportAccording to the Journal of Accountancy, the IRS has increased resources devoted to scrutinizing alimony, or spousal support.  

As is well known amongst divorcing individuals and the professionals who support them, the tax code allows the payor of spousal support to deduct it from taxable income, while the recipient must include it in taxable income. So if Kevin pays Kate $30,000 of spousal support a year, he can reduce his taxable income by that amount while she is supposed to claim it as income, and pay taxes. 

Predictably, divorced couples don’t agree about spousal support any more than they do about anything else. On March 31 2014, TIGTA , the Treasury Inspector General for Tax Administration, an IRS watchdog, issued a report identifying a large tax gap between spousal support deductions by payers and the corresponding income claimed on ex-spouses’ returns.

With its mouthful of a title (“Significant Discrepancies exist  between Alimony Deductions Claimed by Payers and Income Reported by Recipients“), TIGTA clearly wants us to pay attention.  TIGTA found that for the 570,000 returns that they analyzed for the tax year 2010, deductions exceeded income by more than $2.3 billion. More than 47% of returns showed discrepancies between the spousal payments deducted and the income reported.

According to Mike Conti, a CPA in Boston, TIGTA estimated that the IRS revenue loss from spousal support errors could add up to $1.7 billion over a five year period. Although that is small compared to the estimated $385 billion tax gap experienced in the US, spousal support is now a target for the IRS that has been identified and quantified. 

In fact, the IRS reported adjusting its audit filters to catch more high risk returns. The WSJ reports that the IRS is developing “other strategies” to address the spousal support tax gap. In other words, divorcing individuals, at least those paying and receiving spousal support will be at a higher risk for an audit.

There are enough things going on in a divorce that a potential IRS audit may not make it to the top of the list of concerns.  However, given that it is now completely predictable, it is better for divorcing individuals to pay the extra attention and avoid the audit or be ready for it.

For people paying spousal support as well as for those receiving it, it is important to ensure that:

1. You fully understand what is alimony and what is not. Separation agreements are written in a legal style that is not always clear to non-lawyers. If you are not sure, if you have questions check with a financial specialist such as a CFP® professional, a Certified Divorce Financial Analyst (CDFA) or a CPA.

2. You agree with your ex on what spousal support amount you are putting on your respective tax returns. Having a discrepancy between what he files and what she files could put both of you at greater risk for an audit.

3. Your separation agreement correctly specifies spousal support. If it does not and you get audited, alimony could get disallowed. If you have not done so already, take the opportunity to verify that your separation agreement correctly specifies spousal support.

4. You get professional post-divorce support. You will need it anyway for any number of other issues. Analyzing spousal support and filing taxes correctly are just two of them.

5. Avoid pushing the envelope on this issue. It is simply not worth the additional aggravation. 

(a version of this post appeared on boston.com)