Do-it-yourself divorce mistake #2

Jim Suits, President, Summit Capital Advisors (jsuits@summitcapitaladvisors.net) had this story to tell after reading the last entry:

"Your last blog entry reminds me of a case we had where a tax client who came in to have his taxes done. He and his wife of 30+ years had gotten a divorce the year before. To save attorney fees, they downloaded the forms and "filled in the blanks" without help. The husband took them to an attorney and asked: will this work? The attorney looked at the papers and said: Yes.

"One item in the divorce stated that the wife was entitled to 50% of his 401k. So, after the divorce the husband withdrew her 50% from the account and wrote her a personal check. It was after that, that he came in to have his taxes done. Imagine his surprise when he was hit with early withdrawal penalties and income taxes totalling more than $100,000. Then came that famous question "Why didn't someone tell me?"

"(Because you wanted to save a nickel, that's why!)"

Do-it-yourself divorce mistake

When Michelle and Scott got divorced, they didn't want to spend money on an attorney so they got the forms and did it themselves. They had no children so the only issue was dividing the property. They decided to split all of their assets 50/50 and their final agreement stated that "they would divide each asset equally." Their assets included a $24,000 savings account and a $104,000 mutual fund, both in joint names.

After the divorce was final, they each had pressing business issues and kept putting off the paperwork needed to divide the two accounts. After a year had passed, Scott finally found time to get the savings account and the mutual fund divided. Imagine their surprise when they were hit with gift taxes!

The Tax Reform Act of 1984 says that transfer of property is incident to divorce if it occurs within one year of the divorce OR the transfer is stated in the divorce decree and occurs not more than six years after the divorce.

They could have avoided the tax problem they found themselves in if they had consulted with an attorney and (1) stated in their final agreement the specific assets that were to be divided, or (2) realized the importance of dividing the assets within the first year after divorce.

Is there additional income?

Janine was getting divorced from Mark, a highly paid executive who worked on Wall Street in New York City. They couldn't reach a settlement and in February of this year, we were ready to go to court to have the judge decide. Mark showed on his financial disclosure that he earned $500,000 per year.

I was the Financial Divorce Expert on this case and after we reached the courtroom, I was given a copy of Mark's W-2 for his 2006 wages. After looking at it, I was able to get on the stand and testify that Mark's yearly income was actually $600,000!

If you will look at a W-2 form, you will notice several boxes. Box 1 shows "Wages, tips, other comp." Box 2 shows "Social Security Wages." Box 3 shows "Medicare wages and tips." On Mark's W-2, Box 1 showed $500,000, which is what he was reporting. But Box 3 showed $600,000. Why the difference? It is because Mark was contributing $100,000 per year to his retirement plan which was deductible so that Box 1 showed only his taxable wages.

Because I could testify that Mark still owned that $100,000 - it was just in a different account (his retirement account) - he had that much more money to use toward paying alimony.

The Judge ordered sizable alimony for Janine, her attorney was surprised, and everyone was happy (except Mark!).

Divorce money saving tip

Here's a tip that most people don't know about. More and more people are now buying long term care insurance. The lower earning spouse in a divorce may be especially concerned about how to pay the bills if they have to go to assisted living or a nursing home later in their life.

Michelle and Kyle were getting divorced. Michelle was very worried about growing old by herself and what would happen to her if she became ill. She found out that if she and Kyle applied for long term care insurance before they divorced, they would get a "couple's" discount of up to 30-40%. And after the divorce was final, the premium would not go up - the discount still applied so they both saved money.

But what if Michelle wanted the long term care insurance and Kyle didn't? Michelle could still get a couple's discount but it would be lower - perhaps only 15-20%.

Every little bit helps and over years of paying premiums, this discount can really make a difference!

Modification of Child Support

Kate and Alec had two children, ages 5 and 7, when they divorced. No matter what Kate said, Alec refused to include in their divorce agreement a clause which would increase child support each year by inflation. As the children grew up, they became more expensive and Kate was having trouble making ends meet. She contacted Alec to tell him about her situation and how much the children's expenses had increased. Alec said, "So sue me." So she did.

After being served with a court date, Alec reluctantly agreed to increase child support to the amount according to the child support guidelines, using his current income and the children's current expenses, not the income and expenses at the time of the divorce.

Every parent knows first hand, the expense that goes into raising a child in this day and age. This becomes an even more daunting expense when two incomes suddenly become one. Children often become pawns in the midst of divorce proceedings, whether intentional or not.

Remember---child support is ALWAYS modifiable.

Research the value of retirement assets

Janet and Kevin are in the midst of a divorce. Kevin has a defined benefit pension which will pay him $2,300 per month when he retires. Janet decides that a few thousand dollars is not worth fighting over - besides she would rather get the $12,000 baby-grand piano they recently purchased for their den.

Wrong decision. Janet has made a costly mistake. Why? Because the present value of Kevin's pension is more than $250,000! Instead of taking the piano, she could have exchanged her half of Kevin's pension upfront for $125,000 worth of another asset, leaving Kevin with is pension. Or she could have chosen to wait until Kevin retires to get her part of the marital portion of his benefit. What seemed to have only been a few thousand dollars on the surface, proved to be a costly mistake in the end.

To get a FREE report "Top 10 Money Mistakes in Divorce," go to www.carolannwilson.com.

Dividing assets in a divorce

Dividing your property can be one of the most challenging and convoluted aspects of your divorce. What appears to be an easy decision such as I want the house, you keep the cars, may in the end deliver you a settlement you hadn't bargained for.

Janet and Jake are getting divorced and they are both age 64. They had two assets: a 401k worth $120,000 and a money market worth $120,000. Janet was really concerned about retirement and wanted to take the retirement fund. It felt more secure to her. Two years later, they each wanted to buy a small house. Jake took $90,000 for a down payment out of his money market fund to make the down payment on his house. Janet asked for $90,000 from the 401k to make a down payment on her house but the net amount she realized was only $60,000 due to the taxes she owed on money from a retirement fund!

Remember that you cannot compare a cash account with a retirement fund because of the tax issues. This is one area that many people do not think about.