In previous columns, we've examined how a variety of independent advisors--from solo practices to firms with offices in several cities--use outside specialists to provide the best service for clients. While the management and selection of teams varies, flexibility and matching client needs with the right expert are constant themes.
One of the most emotionally and financially challenging events for financial advisors is the divorce of a client--or worse, the divorce of a couple when you've worked closely with both parties. When analyzing the client situation in the stages before a divorce settlement, advisors have learned that the division of assets is not a simple case of dividing everything by two. The subtleties of financial settlement in divorce render it a specialty beyond what most financial planners handle on a daily basis.
Getting the Details
Carol Ann Wilson is a CFP and a CFDP--Certified Financial Divorce Practitioner--in Longmont, Colorado, who has specialized in this area for decades and is the founder of the Institute for Certified Divorce Planners. She's found over the years that even divorce attorneys need help in understanding the financial side of divorce, such as using the tax code to benefit their clients.
Wilson recalls one case where an overlooked detail about the husband's job perqs completely changed the attorney and client's understanding of the case. The wife had already moved to Colorado, while the husband was back east as the CEO of a major corporation. As Wilson tried to assemble a list of assets, the client's attorney stated that he didn't believe the husband's corporation had a defined benefit plan. Wilson knew otherwise and requested that the attorney ask the question directly and probe deeper. As it turned out, the husband did have substantial assets through the plan. Since the attorney hadn't asked about the plan previously, the husband wasn't volunteering any additional information.
Wilson had another case where an attorney with whom she had collaborated several times called about a $45 million case. The attorney said that the husband was offering his client $8 million. "Don't you think that that's enough? She doesn't need more than that," the attorney told her. Wilson told him that half would be a place to start negotiating and it wasn't just about need. It was about the couple's history together and the history of the accumulation and growth of their assets.
"Often, the husband is either the CEO or a top executive of a large corporation, and is making anywhere from half to $1 million annually and they have millions in assets," Wilson says.
"He's usually the one that's pretty tuned in to their financial situation."
When Wilson shows wives graphs of their future finances, they often don't understand why their net worths cannot go up the same as their husbands. Wilson explains that, after the divorce is final, the husband will continue earning a great deal of money, which will increase his net worth. The wife will never have that earning potential--unless she has her own career.
Defining True Value
Another problem Wilson has seen is that couples think about dividing assets without recognizing their true value. One wife even argued that she should take the retirement plan rather than the cash account, which the husband had offered her. She wanted the plan assets to make sure that she would have retirement income, she said. Wilson explained to her that the retirement plan wasn't worth as much as cash because of the taxes due on withdrawal. She didn't get it. She remained hooked on wanting the retirement account. It took a lot of explaining, even to the attorney, but then they understood that the wife's solution wasn't in her best interest.
Joyce Pearson is a CFP and a CDFA (Certified Divorce Financial Analyst) in Scottsdale, Arizona, who specializes in working with clients going through divorce and working with their other advisors through her firm, NetVEST Financial LLC. She consults for couples in mediation through Equitable Divorce Solutions LLC. She says she started thinking about this specialty in 1990 when a client who had just moved from Chicago handed her a check for $800,000 to invest. The amount represented the proceeds from selling a building in her divorce settlement. Pearson started brainstorming about the various ways by which some additional dollars could have come her client's way rather than just a flat-out selling of the asset followed by paying the taxes.
Financial Traps in Divorce
Financial planners who specialize in divorce cases focus on four major planning issues:
- "Equal" is relative. As with the wife who wanted the retirement plan assets instead of cash, clients and even other advisors don't always understand the true net value of assets, which aren't always as obvious as this example. The primary and vacation homes are other examples--both have continuing financial obligations. A divorce specialist would provide an in-depth analysis of whether such assets provide a good solution for the client's particular circumstances.
- The story behind earnings potential of the higher-income earner. If a wife supported her husband as he worked on his MBA or stopped her career to raise the children, she may be entitled to additional payments.
- How taxes affect settlement amounts. That $2 million IRA brings taxes at the time withdrawals are made. A divorce specialist would look carefully at the tax implications of selling homes or property as part of the settlement. It can also be a negotiating tactic. Wilson notes that if a wife gets the primary house and even if she lives there for four or five years, she'll get her $250,000 exclusion--and so can the husband. He needs to have lived in the house for at least two years and stay on the deed as an owner so the IRS recognizes him. The arrangement also needs to be part of the divorce decree.
- Depending on a spouse for major financial support. Long-term financial dependency of one spouse on the other may raise concerns. If the husband will depend on the wife for monthly payments, for example, he may need to secure his income stream with a life insurance policy on her. The payment of the premiums would be part of the settlement and the insurance expert on the team will need to confirm premium payments. Before both parties reach a settlement, the team should receive confirmation of insurance companies' willingness to underwrite the insured and then purchase a policy from a carrier.
For the same reason, the spouse making the payments needs long-term disability coverage at the maximum insurable amount, which by law is still less than 70% of annual salary. A person is ten times more likely to have a long-term disability during his or her work years than to die during that time.
"One of the biggest challenges I have in working with wives undergoing a divorce is to help them understand that they may not be able to have the same lifestyle that they were afforded before," says Pearson. "That's where I spend time showing them the cash flow and the numbers. Then, they come to that realization." It's emotional, especially in a situation where they're not voluntarily downgrading.
Pearson points out the emotional advantage held by the spouse asking for the divorce. "Let's say you've been married 15 or 20 years. One day, your wife walks in and announces she wants a divorce. She wants it now. The trick is she's been thinking about it for quite a while--and it has hit you over the head like a ton of bricks. You have to play catch-up. Mentally, you have to get to the same mindset that your wife has."
Typically, you go through several different phases: this will blow over; she'll come back to me; we'll make it work; we'll go to counseling, etc. Then, when the realization hits that, no, this is serious, comes the anger. "When we get past that, they're ready to deal with the financial issues and the reality," observes Pearson. "During that period of time, I'm showing them cash flow numbers, but also realizing that many of them will not accept that until they've caught up emotionally."
Then, they're ready to deal with the financial questions. She explains the details so a spouse without a financial background can understand the potential settlement agreement. For example, she'll show a wife how her husband's stock options work--and if she does accept a portion of them as part of the settlement, what's involved. Can they be transferred? What are the tax implications for her? What growth can she anticipate? What is the downfall of accepting? If she doesn't accept them, what will be a potential offset for them?
Divorce specialist also run scenarios of different settlements. If a spouse accepts a particular settlement offer, how will it look five or ten years later? What will be the cash flow?
"I've always said that there are three divorces going on here," say Pearson. "There's an emotional divorce, there's a legal divorce, and then there's a financial divorce."