It’s very common for my clients to be thinking short-term. They are going through one of the most challenging times in their life, and that means they are in survival mode, in most cases, just trying to get through to the other side. Regretfully, this short-term thinking can result in a lot of long-term problems. The financial decisions each couple makes during their divorce will have an impact on their finances for the rest of their lives. Which means doing it with a thoughtful consideration for the future is critical. Let’s take my clients for instance who came to me with a proposal from their attorney.
Husband will retain the home and Wife will receive a buyout via Husband’s retirement accounts. The equity in the home is $200,00 and the buyout via retirement is $200,000.
This seems equal on face-value – they each walk away with $200,000 of assets. But there are a few fundamental flaws that have an impact on this agreement.
1. Taxes. First, a buyout for home and retirement value are not equal due to taxes. A house buyout is generally post-tax – i.e. it is a buyout from one spouse to another and will not be taxed if drafted properly in the divorce decree/settlement agreement. Retirement accounts on the other hand, in this case traditional IRA and 401(k), are pre-tax – i.e. they will be taxed in the future. Thus, the value of $200,000 in retirement is not worth $200,000. It is worth $200,000 minus taxes depending on Wife’s tax bracket, So the values are not equal.
2. Age. Second, in this situation, Husband was of retirement age (over 59.5 years old) and Wife was in her 40’s. In order for Wife to access money from the retirement accounts, which would be likely as this would be her main asset, she would likely have penalties of around 10%, as she is not yet of retirement age. So, while on face-value it looks like they are each walking away with an asset, Wife would be penalized for liquidating hers to use before she reached retirement age, except in very unique circumstances.
It may look equal, but this example shows that looking not just at today but into the future, has an impact on the agreements you reach. It’s important to be considerate of how agreements will impact you long-term and what your goals are for the future, so you can make educated financial decisions today.
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