What If's in Divorce??????

[Lili Vasileff]

How to Answer Those  “What If’s” for Gray Divorces

By Lili A. Vasileff, CFP®, CDFA™

The scope of divorce financial planning is integral to every legal process: litigation, mediation, and collaborative divorce.  A divorce financial planning expert is involved in the divorce process itself, which has long term carryover potential for post divorce follow up and planning.  Forging a team effort with the attorney results in value added for the client, client referrals, and reduced potential for professional liability.

Complexity of Planning Decisions for Gray Divorces:   

1. What cash flows are available approaching retirement and during retirement years?
2. Analyze risk tolerance and appropriateness of investments to keep or liquidate at whose
   cost and what tax impact?
3. Project longevity of assets for managing expectations or spending behaviors;
4. Prioritize debt payoffs;
5. Maximize finite resources and manage speculative needs

 

Even though their financial health may have been seriously impaired over last few years by economic
downturn, most married couples are not in sync when it comes to their retirement. Struck with the probability of facing divorce, very often, their perception of how to plan for retirement years becomes ever more acute.

 

A survey by Fidelity was aired in late 2009 of intact households ranging from 42 to 75 yrs, with income of $75 K or more, investable assets of $100K or more.

• Less than 1/3 make decisions together about retirement savings plans
• Only 15% are confident that in the event of their partner’s death, they would be
  able to assume financial responsibility
• 60% of couples have different goals for retirement
• Half are not in agreement as to working in retirement

If discord and lack of communication surround retirement planning for married couples of the baby boomer generation, there clearly is a vast need to address these issues during the divorcen process if one hopes to achieve a lasting outcome. 

 

Clients we see as qualifying Boomers entering their fifties contemplate two things from divorce: freedom and
longevity. Most stories relay “It’s my time and if I don’t take it now, I never will” – few have regrets about divorcing and quite frankly, divorcing has become easier with the stigma disappearing and both men and women having enough money to make changes. 

 

Let me share with you a few examples of real life boomer divorces. Each was a learning experience in how to
address the what-if’s in divorce.

Story subjects include:

1. Paying for college – haven’t saved enough – what’s new in 2011

2. Social Security benefits & maximizing strategies

 

 

(1) Paying for College:   Haven’t Saved Enough

Question:

My ex-wife and I have more than $150,000 in Roth IRAs in addition to another $500,000 in retirement savings in our
401K plans. We have zero in a 529 plan or other college savings.

With our first child 5 years away from college, we are concerned that ROTH IRA contribution withdrawals may not be a good vehicle for college tuition as the withdrawals show up as income on each parent’s financial aid application even though it is not taxable income. This may affect ability of our child to obtain student loans.

We are considering cutting back on our 401K contributions and saving aggressively in a 529 plan.  Thoughts?

Answer:

If these parents (ex-spouses) were 100% certain they would be paying for college in the future, my response is to go ahead and redirect some of their retirement savings to a 529 plan. 

The benefits are:

• lock in tax free earnings
• do not have to wait until age 59 1/2, as they would with their 401K plans and ROTH IRAs, to take withdrawals
• avoid negative financial aid impact of withdrawing from a ROTH IRA or 401K plan, realizing that the aid formula considers withdrawals to be income (whether or not any portion of them appears as income on their individual income tax return).  In contrast, tax free withdrawals from a parent or student owned 529 plans
  are not reported as income on the financial aid application.

Some considerations for reducing retirement contributions:

1. One would not choose to forego employer matching of contributions to their 401K plans

2. Target reducing contributions to IRAs first

3.  Be aware that there are many variables at play also

4.  Are there any gift and estate tax consequences to be aware of?

 

Gift and Tax Implications relating to 529 Plans:

In 2011, President Obama signed back into law a massive tax and estate bill that could end up putting billions of additional dollars into 529 plans.  Indirectly, this bill, good through 2012, may cause many wealthy parents and grandparents to think about upping their contributions to 529 plans. The new law unifies the exclusions for gifts and
estates, which means the gift tax lifetime exclusion and the estate tax exclusion both are set at $5 million.

Let’s say Grandma Ida has a $4 million estate and is thinking about contributing $100,000 to a 529 plan for her grandson. Even with the 5 year election sheltering of $65,000 of that contribution, she would be left with a $35,000 taxable gift to apply against her gift tax lifetime exclusion. In the past the use of her gift tax lifetime exclusion reduced her estate tax lifetime exclusion. Absent Congressional action, the gift tax lifetime exclusion was headed down to $1million.

But with both set at $5 million and her estate smaller than $5 million, Grandma can use her gift tax lifetime exclusion to shelter very large contributions without causing added estate tax exposure, at least through 2012.

 

Benefits to seize in short term:

• There is less reason to limit annual gifting to $13,000 or to $65,000 with the five year election.
• Anticipating the possibility of future rollbacks in this matching of gift and state tax lifetime exclusions, Grandma’s financial advisors are going to tell her to  “Give, give, give” to reduce her estate while living…
• Most importantly, 529 plans are the ONLY tools that allow for individuals to make a completed gift and retain complete control of the account. Account ownership includes not only the right to change beneficiaries but also the right to reclaim funds at any time and for any purpose (albeit subject to 10% penalty and tax on the account growth if distributed for nonqualified purpose).

 

In divorce, you have the opportunity to perfect a college funding vehicle, minimized negative financial aid impact, and introduced an estate strategy for maintaining control over funds, while maximizing gift and estate tax lifetime exclusions. 

 

(2) Social Security & Maximizing Benefits:

Question:

I am a divorcee who is age 63 and I never remarried. I was married for over 10 years. I have my own Social Security benefit. My ex-husband’s retirement benefit is less than my own Personal Insurance Amount (PIA) (the
basic ss benefit). Could I claim divorced spousal benefit and continue working and then delay claiming my own personal benefit until full retirement age or age 70?

 

Answer:

Absolutely.

Rules:

• You must wait until you reach full retirement age (66 yrs) to apply for your divorced spousal benefit, and not before
• while your 50% share of divorced spousal benefit is lower than your own earned benefit, take the divorced
  spouse benefit at FRA and let your own earned benefit build delayed credits to age 70.
• claiming the divorced spouse benefit will not reduce your own benefit in any way.

The only caveat is this: when filing that you must file at FRA and you must tell SS that you “restrict your application to your divorced spouse benefit”. Otherwise, SSA worker might see your own benefit is higher and tell you to take
your own benefit. By restricting your application, your own benefit is not included in the process.

 

Question:

What if instead, my ex-husband is deceased? Can I apply for survivor benefits early?

Answer:

Absolutely, this is a strategy for maximizing survivor benefits.

Rules:

• When his benefit is lower than yours, take your survivor benefit early and let yout own earned benefit build delayed credits to age 70.  The only caveat in this example is that the survivor benefit will be subject to the earnings test before Full Retirement Age. So if you earn more than $14,160 per year, $1 for every $2 in benefits will be withheld for earnings over $14,460 per year.  If you earn enough that all benefits would be withheld,
  you can simply wait until age 66 you apply for survivor benefits and then switch back to
  your own maximum benefit at age 70.

There are so many more what if’s to share but it isclear to see how a client depends upon our knowledge and our financial planning skills during the divorce process.  As divorce financial planners, we help navigate them to financial security and confidence.  Many times it involves emotional coaching to reach resolutions. In the end, there is tremendous potential to conclude reasonable and practical outcomes for our clients that allows them to move forward in their lives.

 

FPA and NAPFA member, Speaker at Women's Advisor Forum, Lili A. Vasileff, CFP®, CDFA™ is the President of the Association of Divorce Financial Planners, the largest national not for profit organization of divorce
financial planners and allied divorce professionals, and President of her own
private practice called Divorce and Money Matters, LLC.  She can be reached at www.divorcematters.com