A Few Common Myths about Divorce
DRCC would like to thank guest blogger, Jenny Arribau, for this piece. Jenny is a presenter with the Second Saturday series through Divorce Resource Denver, an affiliate of Divorce Resource Centre of Colorado.
Myth #1: Getting a divorce means you didn’t try hard enough.
When I left my marriage, I didn’t leave because I didn’t try to fix it first. I did. I left because I realized that I was the one that wanted to change, so there was no way for either of us to be happy and stay in our marriage. By working with people as a divorce recovery therapist, I have found that this is true for most couples that divorce.
In my view, if one person does not want to change and the other one does, there is simply no way to grow together, and ending the marriage is the healthiest option for both people.
Myth #2: Divorce is just a transition, not a major loss.
Another story I told myself during my divorce (and my clients often catch themselves believing this too) is that divorce is not a major loss that we grieve, like the death of a loved one. Not true. Divorce is a major loss, often just as, if not more difficult than the loss of a loved one. We might tell ourselves that it’s not so we can push away our pain; I know I did at times. Divorce is the loss of not just our spouse, but our marriage, our family unit if we have kids, our home if we move: our life as we know it. If you are going through a divorce and you are grieving, it is to be expected. It is normal, and knowing that we are not alone is the first step to getting better.
Myth #3: If we loved our ex-spouse, we can never really get over our divorce.
Like many people who divorce, I was in love with my ex-husband throughout our marriage. We had many wonderful times together, and I have no regrets. I learned so much about myself by addressing and resolving my grief, and I wouldn’t be who I am today had I chosen another path. Working on myself, and everything my divorce brought up for me freed me to stop asking someone else to make me happy, and start giving myself the life that I have always wanted.
Healing was a challenge and a gift; I worked hard to go inside myself and resolve my grief, and as a result, I know how strong I am. It has also helped me show up more fully in all areas of my life, especially in my romantic relationships. Now I get to teach others to do the same for themselves.
If you are going through, or have gone through a divorce, I hope that you’ll get the support and the tools you need in this challenging time. Asking for help is a sign of strength… I could not have healed myself without the guidance of my amazing teacher. If you want it, there is a new life, and a new, healthy way to do your relationships just waiting for you. If you do the work for you, I think you’ll find that you are far too valuable, and too amazing a gift to miss out on.
Jenny Arribau is Licensed Professional Counselor specializing in divorce and breakup recovery in Denver, Colorado. You can find out more about her services here.
Accessing Money from a Defined Contribution Plan Without the 10% penalty
Normally, distributions made before the participant attains age 59-1/2 are called “early distributions,” and are subject to a 10% penalty tax. The tax does not apply to early distributions upon death, disability, annuity payments for the life expectancy of the individual, or distributions made to an ex-spouse by a QDRO.
The tax Reg (72)(t)(2)(C) states that when you take money out of a qualified plan in accordance with a written divorce instrument (a QDRO), the recipient can spend any or all of it without paying the 10% penalty.
Let’s take a look at what happens when the ex-spouse receives the 401(k) asset. There are some specific rules to be aware of.
Here’s an example.
Sarah was married to an airline pilot who was nearing retirement. They were both age 55. There was $640,000 inhis 401(k) and the retirement plan was prepared to transfer $320,000 to her IRA. She could transfer the money to an IRA and pay no taxes on this amount until she withdraws funds from the IRA. But Sarah’s attorney’s fees were $60,000 and she needed another $20,000 to fix her roof. She said, “I need $80,000.”
Because the 401(k) withholds 20% to apply toward taxes on a withdrawal, Sarah asked for $100,000. After the 20% withholding, she had $80,000 in cash and $220,000 to transfer to her IRA. She was able to spend the $80,000 without incurring a 10% penalty on the $100,000, which saved her $10,000 in penalties.
After the money from a pension plan goes into an IRA, which is not considered a qualified plan, Sarah is held to the early withdrawal rule. If she says, “Oh I forgot, I need another $5,000 to buy a car,” it is too late.
She will have to pay the 10% penalty and the taxes on that money. Or, if Sarah’s financial advisor did not know about this rule and established an IRA to receive the funds from the QDRO, and then she decided to take a withdrawal to pay her attorney’s fees (or a withdrawal for ANY other reason); she would be assessed a penalty of 10% in addition to the normal ordinary income tax due on the distribution.
Types of Qualified Plans
It is important to understand the subtle differences when transferring money from qualified plans. One type is a direct rollover where the check is made payable to the company where the IRA is held; not payable to the client. The check may be sent directly to the IRA custodian or the client, however, the check is made payable to the custodian of the funds.
The other type is a 60-day rollover, where the distribution is made payable to the client with 20% withheld for Federal taxes. It is then up to the client to get the funds back into an IRA within 60 days. Additionally, the client must put in the additional 20% withheld for federal taxes for the entire transaction to be a non-taxable event.
The Unemployment Compensation Amendment Act (UCA), which took effect in January 1993, stated that any monies taken out of a qualified plan or tax-sheltered annuity would be subject to 20% withholding. This rule does not apply to IRAs or SEPs.
In other words, if money is transferred from a qualified plan to an IRA, the check is sent directly from the qualified plan to the IRA. In a rollover, the funds are paid to the person who then remits the money to an IRA. A payment to the person, whether or not there is a rollover, is subject to the 20% withholding. Only a direct transfer avoids the withholding tax.
This is a great planning tool when clients have a need for cash and there is no other way to get it.
It has been said that divorce lawyers have the highest number of malpractice claims. One reason may be that while advising their clients on settlement issues, the lawyer may be giving improper financial advice. This is commonly due to the constant changes in tax law and perhaps the fact that the divorce lawyer’s expertise is in the law, not in taxes.
Basis in Property is a Big Issue
After being involved with over thousands of divorce cases, we find that the one question most overlooked by divorce professionals is: What is the basis in the house (or stocks, other real estate, or other investments in the couple’s portfolio)? Consider the following case study.
Melanie and Mac have been married for 18 years. They have no children. They have decided everything except how to divide the remaining three assets equally. Those assets are a cottage in Hawaii worth $350,000, an IRA worth $150,000 and a savings account worth $250,000. The $250,000 in the savings account represents a loan taken against the cottage in Hawaii.
Mac proposed to Melanie that she take the cottage and sell it. She would net $100,000. And she should also take the IRA worth $150,000. He would take the savings account and they would each end up with $250,000.
His proposal looked like this:
Melanie talked this over with her attorney and they thought that this sounded fair. But, is this truly an equal division? It depends on. . . . THE BASIS?”
Had the divorce professional inquired about the basis in these assets, it would have been revealed that Mac had paid $90,000 for the cottage 15 years earlier. It was sold at an incredible estate sale. There was a $260,000 capital gain, which created a tax of $52,000 (capital gains tax at 15% plus state tax at 5%). Melanie received $100,000 and had to pay out $52,000, so she had only $48,000 left.
The after-tax value of the IRA is approximately $100,000 (not counting penalties as she is not planning to liquidate it immediately), so Melanie ends up with $148,000. The $250,000 that Mac borrowed from the cabin and put in the savings account was his, tax-free and clear.
He ends up with $250,000 and she ends up with $148,000, because the question was not asked about the basis. Do you think Melanie’s attorney had some liability here? Absolutely!
Be sure to investigate the basis in all assets. Then there will be no surprises.
Can We Sell Our Home Before We are Officially Divorced?
If you’re thinking about beginning divorce proceedings, chances are your combined marital assets are weighing heavily on your mind. What will the outcome be? Can we afford to support two households? How will the changes in income affect our children?
When it comes to assets, often the family home is a big part of the financial picture and figuring out all of your options might feel overwhelming. So, let’s take a look at what you should be considering when it comes to your real estate investments and working through mediation.
Let’s start from the beginning.
When we look at the real estate that a couple jointly owns, we’re including not only the residence, but also any rentals, timeshares, and land. We also know it is important to do a complete forward-looking cash flow analysis; this helps the client see the future financial picture of home ownership. Through this process, we can show them what price ranges make the most financial sense once the household is divided into two.
What if we decide to sell our home before the divorce is final?
Should the clients have children still living at home and decide to sell, we encourage them to spend some time looking at the following:
1. Different neighborhoods
2. School districts
3. Proximity to the other parent
4. Nearness to the children’s activities.
For those clients who are considering divorce and are closer to their retirement date, it is also important for them look ahead at the following:
1. Amenities they would need/enjoy in their retirement.
2. What type of home they would prefer (one-story, retirement community, etc.).
3. Proximity to healthcare facilities.
When it comes to the logistics of the sale, it’s also important to work through the details of the transaction. Here are some other factors to consider:
1. Who is going to pay for the normal expenses during the pendency of the sale?
2. Who is responsible for the ‘market readiness costs?
3. If one spouse pays the expenses, will they be reimbursed from the proceeds?
4. How will you select a realtor?
5. How will the net sales proceeds be divided?
Sometimes, especially in the current Colorado real estate market, a marital residence must be sold in order to secure another residence. Because this transaction and its timing is so complex, it is of utmost importance that all angles are analyzed, and the impact known; this includes the moving and market readiness costs that are involved and how the marital residence is titled along with other potential issues with lenders.
Therefore, we feel that it’s important to choose a mediator who works closely with realtors and lending professionals to make certain that this transaction is doable prior to the finality of the divorce and that it can be done without any potential future negative results.
The bottom line is: It is possible to sell the residence during the pendency of the divorce, but it must be carefully analyzed.