Killing Alimony

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

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

Five Common Questions About Divorce

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

5 Common Questions About Retirement and Divorce

Retirement 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:

A previous version of this post was published in Investopedia

Getting Help When You Need It Most

By Chris Chen CFP | Divorce Planning , Financial Planning

When “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

Alimony…not far from Acrimony

By Thomas Seder | Divorce Planning , Financial Planning

A 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!

Pension Division in Divorce

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

 

Pension Division in Divorce

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.

Steps to a Divorce Diagnostic

By Chris Chen CFP | Divorce Planning

People 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)

The IRS thinks you are cheating on your Spousal Support

By Chris Chen CFP | Divorce Planning , Financial Planning

According 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)

Divorce and Empowerment

By Diane Pappas | Divorce Planning

Are you financially empowered? To answer this question, one must first know what it means to be financially empowered. The definition of the word empower is: to enable or to promote the self-actualization or influence of. Becoming knowledgeable about your finances can be an empowering experience, enabling you to realize a more secure financial future. Being financially empowered means making informed and effective decisions about the use and management of your money. Having the knowledge, skills and access to appropriate tools to effectively manage your finances, will help you and your family improve your long-term financial well-being.

But, if you are currently going through a divorce, your ability to make informed decisions about your financial future may be compromised, especially if you do not have a clear understanding of your finances.

One way towards empowerment during the divorce process is to seek the help of a divorce financial professional. A Certified Divorce Financial Analyst™ (CDFA), can become a valuable member of the divorce team, working closely with you and your attorney or mediator, to ensure that the proposed settlement works best for you and your family based on your particular financial situation. A CDFA™ can provide you with peace of mind knowing that all the different options were analyzed with respect to maximizing the available assets and minimizing any negative financial impact.

Many couples facing divorce are filled with fear of the unknown. Most of that fear lies in not knowing what their financial life will look like after divorce. Will I end up a bag lady? Will I be living paycheck to paycheck unable to ever enjoy life again? The best way to alleviate that fear is to know ahead of time what your financial life might look like. Using sophisticated tools, a divorce financial analyst can provide you with a projection of your future financial life. Knowing what your life might be like 5, 10 or even 20 years from now, will help to bring about the clarity and insight necessary to make those important financial decisions.

Clarity can only be achieved when each spouse fully understands what their needs are, what financial resources are available to them and what their options are with respect to different settlements and future impacts. From understanding what your new monthly expenses are going to be, to seeing the impact of the proposed asset split on long-term retirement projections, to understanding your options with regards to keeping or selling the marital home, being empowered with this important information will put you in control of the decision making.

Taking control of your finances will empower you through the divorce process, making it easier to transition into post-divorce life. While the emotional issues will still be present, knowing that you did the best you could with the resources available to you, should allow for the healing to take place. No one wants to worry about money, and when children are involved, it only creates more stress and heartache. Let a divorce financial professional help you achieve financial empowerment from the beginning so that your financial needs and concerns remain the centerpiece of your divorce settlement.

Overturning DOMA

By Chris Chen CFP | Divorce Planning , Financial Planning

Some financial impact from overturning DOMA for same-sex couples 

Today, the Supreme Court struck down the Defense of Marriage Act (DOMA), the 1996 federal law prohibiting married same-sex couples from receiving federal benefits.   According to Justice Kennedy who wrote the majority opinion “DOMA is unconstitutional as a deprivation of the equal liberty of persons that is protected by the Fifth Amendment.”

For states such as Massachusetts where same-sex marriage is legal, federal benefits that were previously unavailable can now be accessed by married same-sex couples.  Many of  the benefits are financial or have a financial impact.  For instance, with DOMA overturned, same-sex couples will now have the ability to file taxes jointly, or to qualify for social security benefits. In addition, same-sex couples can now simplify their legacy planning, since they will be subject to the same rules as opposite-sex couples.

Same-sex couples who divorce  will now be able to get the same benefits as opposite-sex couples.  For example, same-sex divorced couples can now divide property without incurring gift taxes.  When alimony is paid, the payor may now deduct the payments from taxable income.

Divorced same-sex couples may need to revisit their separation agreements.  For those people who have an alimony arrangement, as the alimony amount can now be deducted from the payor, it will also become  taxable to the payee.  Hence the amounts may need to be recalculated to take that new fact into account.   People who have had to pay gift taxes as a result of a property division pursuant to divorce may be able to reclaim those taxes.

These are exciting times for same-sex couples.  Life without DOMA will be easy to settle day to day.  For financial issues, such as financial planning and tax planning it may take a little more adjustment.  Make sure to contact your CFP and CPA for more details.

Start an Emergency Fund

By Chris Chen CFP | Divorce Planning , Financial Planning

This week I wrote the following short piece for the Boston Globe:

Many people have trouble putting together an emergency fund. After all, there is always something else to spend money on! These are often small items, small fees and small purchases that go unnoticed. However, they add up. What if you could limit your purchasing of these small items, and put your extra cash into a rainy day fund instead?

Here are some ideas:

1. Consider giving up your daily Dunkin’ Donuts or Starbucks habit. At $3.05, a cappuccino may not seem like a lot, but one every 251 working days in the year adds to $765. What small expenses do you incur every day that adds up?

2. AT&T and Verizon will charge you $199.99 for the new iPhone5 or the newer Samsung Galaxy 4 with a two year contract. The truth is most of us want the new hot phones and their fancy features. How long will these phones stay “hot”?

3. Pack your lunch: a sandwich or a salad at Panera will set you back $9 a day, or $2,259 a year.

4. Carpooling is great. Biking to work is better: It will not just save you gas, it will make you healthy too. Have you tried Boston Bikes yet?

http://www.boston.com/business/personal-finance/2013/06/14/raining-pouring-how-start-saving/0h0ktD2nYBSVEZ6ILO6nxM/story.html?pg=2