Leah Hadley [00:00:01]:
Welcome to Intentional Divorce Insights. I'm Leah Hadley, certified divorce financial analyst, accredited financial counselor, and the founder of Intentional Divorce Solutions. I'll be your guide through the complexities of divorce, finance, and emotional wellness. Join me as we uncover practical tips and empowering insights to help you navigate your divorce with clarity and intention. Welcome back to intentional divorce insights. Today, I wanna talk about specifically 4 common financial mistakes that people make when they are negotiating their divorce settlement. Now there are lots of mistakes that people make. That's reality.
Leah Hadley [00:00:40]:
People are feeling emotionally overwhelmed when they're going through the divorce process often don't have a financial person in their corner to make sure that they are avoiding some of these very costly mistakes and so unfortunately a lot of these are very common. But first and foremost when I talk about liquid versus illiquid assets I see the mistake that people make often is focusing too much on the illiquid assets and not enough on the liquid assets. So when we talk about liquid and illiquid assets we're talking about how easily an asset can be converted to cash. So your cash your savings those are going to be your most liquid assets whereas your physical property that needs to be sold in order to become cash generally is going to be your most illiquid asset. Now most stocks and mutual funds are fairly liquid you know they have the the stock market is trading on a daily basis. There are some stocks and some types of funds that are less liquid but that's important to really be aware of when you're negotiating what your settlement looks like. How liquid or illiquid are these assets? So why does this even matter? The fact of the matter is that cash or cash equivalents give you freedom they give you flexibility it allows you to really have control over what some of you may want to invest in or like for example furthering your education or maybe investing in a new home or having money for rent or whatever that transition looks like for you having cash or cash alternative assets gives you a lot of flexibility to deal with things that might come up that maybe you didn't expect to come up right don't have to worry about selling those less liquid assets. Now the second one is negotiating to stay in a house that they can't afford.
Leah Hadley [00:02:39]:
Okay, this is very common and there are a lot of reasons that people get really attached to their homes. Some of them are are financial reasons so for example there are a lot of people out there right now who have a mortgage with a very low interest rate. If they were to refinance that mortgage or to go into a new home they would be doing it at a significantly higher interest rate. So there can be a financial connection why you want to stay in that home for sure, But a lot of them are emotional reasons. You know, it's maybe where you raised your family. Maybe you want stability for your children. Maybe you want stability for yourself. So there are a lot of reasons why people are very attached to the marital home and often that can be a sticky issue in divorces when people are negotiating are with staying in your home if that's what you're going to do or that's what you think that you want to do.
Leah Hadley [00:03:37]:
Right, so for example I mentioned before that there are a lot of people who have these very low interest rate mortgages that are great interest rates that you just can't get now in the current economic climate. Well depends on the nature of that mortgage but if you're keeping you're retaining that home it may be if it the mortgage is in both parties names that you're not going to be able to keep that low interest rate. You may in fact have to refinance at a higher interest rate. Now some mortgages are assumable, so there are there are some mortgages that have a clause, it's an assumption of liability clause, that allows 1 or the other party to assume the responsibility for the mortgage if they meet the requirements necessary by the lender, but not all mortgages have that clause and sometimes the mortgage is only in one person's name and it's not in both names. So if it's in the other party's name and you want to keep the home then you would need to refinance in order to get the mortgage into your name. Now the other piece of it is what do you have to give up in order to be able to stay in the home. Right? So home often one of the largest marital assets when we're looking at dividing things and you may or may not have other assets that can offset the equity that you would be retaining in the home. Maybe you do have some retirement accounts and things that you can use to offset the equity of the home, but then you're gonna be in a really rough spot as far as planning for your own retirement because you're giving up all those retirement assets in order to be able to stay in the home.
Leah Hadley [00:05:17]:
So it's not just the cost of, you know, what what the situation is with the mortgage and what you have to do to stay in the home with respect to that, but also really looking at what are you giving up. In some cases you may be doing what's called a buyout where you may be refinancing for more money than what is currently owed on the mortgage in order to be able to buy your spouse out to be able to give them their equity in the house. But then again, you're doing that at a higher interest rate. Right? And so you may or may not be able to afford those payments at that higher interest rate with the larger mortgage balance. So we're looking at all of these different aspects and making sure that you can really afford to stay in the home, but there's more to it than that even. So you're looking at the mortgage, you're trying to figure out does this work? How am I going to get the equity that my spouse is owed from the house? Are they gonna get it through a buyout? Are they gonna get it through offsetting other assets? What does that look like? But then there is the cost of maintaining the home itself right And so for some people that cost can be prohibitive, especially if maybe your spouse was taking care of things like lawn maintenance, home maintenance, and now you're going to have to pay somebody to handle those things, right? You were maybe splitting the utility costs before but now all of those utility costs are falling on you right and so really looking at the full cost of maintaining that home not just the transactional issues that are part of the divorce settlement. It's really important that you don't negotiate for a home that you really can't afford for a couple of reasons. Number 1, you may not actually be able to get the refinancing done which can cause problems in settling your divorce but other things are you know maybe you don't have the cash flow to support that home and that's going to put you in a precarious financial situation.
Leah Hadley [00:07:12]:
Now I hear it all the time that I can't rent something less than what I pay for my mortgage or I can't rent, I can't afford rent relative to my mortgage and that may or may not be the case. You know rents are different all over the country but it's something to consider that you would have the asset, the equity from that asset, that you could invest, that you could use to help pay some of your rent if you were choosing to rent, but also keep in mind that if you have to refinance, you may find that in fact that new payment is the same or more than it would cost to rent, right? And so those are all factors you want to look at the full picture. I personally like to walk people through 3 different scenarios so they can really fully see the options available to them. So if I stay in the house, this is what it's going to look like. This is how we're going to handle getting my spouse their equity. This is how I'm going to handle the monthly cost, the annual costs and whatnot. If I decided to rent this is what that picture would look like, this is what I would do with the equity in the home, these are what my expenses would be, and if I decide to buy again this is what I'm looking at for a down payment, this is what I'm looking at for mortgage payment, this is what I'm looking at for home maintenance, really diving into each of those scenarios and trying very hard to keep an open mind because you may find that in fact one of those scenarios is really going to be much more beneficial than what you had originally thought would be. I had a woman that I was working with in Virginia and we were going through numbers and we were doing the scenario analysis and she actually found that if she rented, not only would she be able to invest the proceeds from the sale of her house but she was actually saving about a $1,000 a month in cash flow.
Leah Hadley [00:09:01]:
Which for a single mom of 3 kids that was a big deal to find out that hey I can actually improve my cash flow dramatically and she found a place that was comfortable for her and her kids. So it's going to be different for everybody you know the the real estate market is different in different areas of the country There's a lot to consider but it's really important that you not keep a house that you really truly cannot afford. Alright. Number 3, common mistakes, not taking the time to understand the tax implications of the property division. Now this is important because different assets are taxed in different ways, and I often see people after a divorce, especially when they're dealing with their legal bills and whatnot pulling money out of retirement accounts in order to be able to pay off debt. Okay Now here's the thing to keep in mind if you have other kinds of assets that you're not gonna be paying ordinary income tax plus potentially an early withdrawal penalty on, those may be better assets to negotiate in your divorce. So that way you don't have this huge tax burden if your plan is to use these funds to pay off debt. Right? So it's really important to know how each asset is taxed and what the implications are going to be for you.
Leah Hadley [00:10:19]:
So some common ones to keep in mind you know when we're looking at the house we want to know what the cost basis is of the home, what you purchase it for, what kinds of capital investments did you make in the home, and then what's it worth if it were to sell. There are some tax benefits associated with selling a home that you you might wanna be, you know, make sure that you fully understand. For example, there's a $250,000 capital gains exclusion on a sale of a home for 1 person, but there's a $500,000 capital gains exclusion for the sale of a home for 2 people. Well if you have a significant capital gain on your home and you've negotiated to maintain that home but then a year later are planning to sell it, well you may be paying a whole lot more in taxes than you had planned because you could have sold it jointly, and then gotten that $500,000 capital gains exclusion. Now I recognize home prices vary widely throughout the country. That's more relevant in some areas than it is in others but I think it's important to know it's important to be aware of right. When it comes to retirement accounts your traditional IRAs are pre tax they grow tax deferred and then when you take distributions out of them they are taxed as ordinary income. If you take distributions before age 59a half, they're taxed as ordinary income plus an early withdrawal penalty assuming that you don't have a qualifying reason to to take the early withdrawal without penalty.
Leah Hadley [00:11:52]:
Roth IRAs, the money goes in after tax, it grows tax free, and then, it comes out tax free for distribution so the money has already been taxed when you put it into the account, so it's growing tax free it comes out tax free right. 401ks can be either pre tax or they can be after tax Roth 401ks, so it's really important to know when you're looking at a statement sometimes people have both. So what are we actually looking at in terms of the numbers and the taxation on each of these individual assets? So it's really important to understand those things. I often see people, having, like, a balance sheet that's just a static balance sheet in Excel and what happens is when you just have that static balance sheet that you're looking at you may not realize that this is a taxable account, this is a tax free account, this is a pre tax account, right? So it's really important to to have more information about what the cost basis is of your assets when you're looking at it rather than just the static value of the account at a particular time. Okay and the last mistake that I want to go over today comes up when people are negotiating pensions. Now I recognize that there are fewer and fewer pensions but we still have pensions come up quite a bit in our practice, especially public pensions are still fairly common and so it's really important that when you negotiate a pension now I mentioned earlier that for a lot of people the marital home may be the largest asset but for people with pensions often the pension is actually the largest marital asset and so you really want to understand in detail what you are negotiating when it comes to negotiating the pension. So first of all what is a pension? A pension is, you know money that you and or your employer are putting into an account for you to grow to get a payment in retirement. So that might be a monthly repayment that you get in retirement, it might be quarterly, it might be annual, but basically the money is put in to grow to give you some kind of a payment in retirement throughout your retirement.
Leah Hadley [00:14:04]:
Now it's not always just a payment sometimes there are health care benefits associated with that, sometimes there are other kinds of benefits associated with that pension benefit in the future. So it's really important to fully understand the nature of that benefit so that way you know what you're negotiating. Now what is the value of that benefit? If it's payments in the future, how do we value that pension? Well here's the thing, there's often a value on a statement that shows what has been contributed to that pension, but that's not necessarily the value of the pension itself. The value of the pension is going to be those future payments that you've earned discounted back to the present value, and that's going to give you a number that you can't find on a pension statement. And so it's really important if you're negotiating an offset on a pension that you really truly understand what is the value of that pension and should I you know how much should I be offsetting it with right. We also want to consider all of the different risks and rewards with any specific investment or asset. Right? So one of the things to consider with a pension is that they are not generally designed to keep up with inflation. So if you're giving up retirement assets to keep your pension you may not want to give up all of the different retirement accounts because that might be a way for you to fight inflation in the future, with something in addition to a pension.
Leah Hadley [00:15:32]:
Right? So maybe for you it makes sense to actually divide the pension in some way. Again, if you're dividing the pension, make sure you understand all of the pieces that you need to negotiate in order to be able to, thoughtfully handle that those negotiations. So that was 4 different common mistakes that people make when they are dividing, assets in a divorce. Member number 1 was not considering liquidity. Right? So focusing more on the illiquid assets and not necessarily on the liquid assets that might be more important to giving you freedom and flexibility. Number 2 is negotiating to stay in a home that they couldn't afford. That's a very common one and we talked at length about that. Number 3 is not understanding the tax implications of your property division and last but not least negotiating a pension without fully understanding the value or benefits of that pension.
Leah Hadley [00:16:29]:
So I know we covered a lot in a short period of time. I hope you found this helpful. If you did find it helpful, please take the time to review the podcast and so others will find the information that they need. We'll see you next week. Thank you for joining me on Intentional Divorce Insights. It's a privilege to share this time with you. I hope each episode offers valuable guidance to navigate your journey. If you find our content helpful, please leave a review to help others discover the benefits of intentional decision making in divorce.
Leah Hadley [00:17:00]:
Until next time, take care and continue to embrace your path with intention.
