The following post comes from Craig Guillot at partner site Mintlife.
Divorce is not only an emotionally trying experience, but it can be a financially devastating one as well. According to the website Maritalstatus.com, the average cost of a divorce in the United States now runs about $20,000. From legal fees and alimony payments, to the division of assets and possible tax consequences, the costs can easily grow even higher.
The expenses of a divorce are unlikely to deter a couple that truly needs to split, but experts say you should still be aware of just how high the bill can get. It some cases, the financial consequences can set you back decades.
Financial consequences for everyone
When it comes to divorce, Hollywood and pop culture often portray the highest-earning spouse being taken to the cleaners. But the reality is, both spouses face financial damage. Nathan Cobert, CFP, of Cobert Financial Group in San Francisco, says while a growing number of spouses both work and have comparable incomes, the majority of marriages still have a primary “resource spouse” and a “non-resource spouse.”
“There’s usually a spouse who is afraid they’re going to be bled dry and another who is afraid they’re going to be homeless. It’s always a financial problem for both,” Cobert said.
The first financial burden is the separation of one household into two. While one person may remain in the home, even if only temporarily, the other has to find a new place to live. Not only are there two rents or mortgages but two cable bills, two utility bills, two health insurance bills and there is no longer the bulk savings on things like groceries. Almost overnight, the living expenses for the couple double while their combined income likely remains the same.
“It’s a lot more expensive to maintain two separate households and you’re having to do it on the same amount of income,” said Jeff Landers, CDFA, President of Bedrock Divorce Advisors in New York.
Capital gains can be a killer
Divorce can come with big tax bills. In many cases, when a couple splits, they may immediately start scrambling to claim or divide assets. It’s not uncommon for a spouse to run and clear out bank accounts, cash in CDs and sell off stocks, bonds and other investments. Blinded by emotion and fear, Cobert says they can be hit with a harsh reality when tax time comes around.
“People are not often aware that there are consequences for cashing out certain assets. Spouses may want to get the money or may need it for income, but the taxes can really add up,” Cobert says.
Let’s say the couple had $100,000 of investments in a joint account. If they liquidated their portfolio and the cost basis of those stocks was $70,000, they could each be on the hook for the taxes on $15,000 of capital gains. If the money was in a traditional IRA and they sold off the stock and took the money before they were age 59 1/2, they could be on the hook for the entire amount in the account – essentially adding $100,000 to their joint income – as well as a 10 percent penalty.
Spousal support quickly adds up
The granting of alimony (also known as “spousal support”) and how it is calculated varies significantly from state to state. Alimony is usually paid to the less-advantaged spouse and is often seen as a temporary measure to help them regain their financial footing after a divorce.
Landers says the first determining factor is the length of the marriage. Although it can vary, in most jurisdictions a couple must have been married for at least ten years for alimony to be a consideration. Other factors include how old the spouse is, whether or not they have a job, how much they earn, any other assets they have, the nature of the dissolution of the marriage, and the need.
“There is no set formula. It’s very subjective. You could be in the same state, have two different judges, and the same set of circumstances, and end up with very different conclusions,” says Landers.
Cobert also says it can vary widely, but in general, the “resource spouse” might have to pay 50 percent of their income minus 40 percent of the income being earned by the non-income spouse. Others say it often works out to ensure that both homes have around the same average income. Often, if there is a child involved, child support is the priority and is calculated first. In any case, if alimony payments are awarded, the paying spouse could have to pay a significant amount of their income to the other spouse for a number of years. The only good news if you’re that spouse: Alimony is typically tax-deductible.
“It’s usually determined by the judge. That’s why we recommend Alternative Dispute Resolution so both parties can come to a fair agreement,” Cobert says.
Don’t forget the legal fees
No matter how amicable a divorce may be, there are going to be significant legal fees. Attorney fees add up quickly because the couple is often paying for not just one, but two legal teams. Even an amicable do-it-yourself divorce can still cost more than $1,500 in many jurisdictions. Landers says the problem is that when a relationship deteriorates to the point of divorce, very few couples do it amicably.
“If they were able to do it amicably, they might be able to go with mediation and it might not cost a lot of money. But if they were that amicable, they might not be getting a divorce,” says Landers.
And the more a couple disagrees and fights it out in court, the more expensive it becomes. Throw in a custody battle and a fight over alimony and assets, and legal fees could easily top $100,000. Things get even worse and more expensive when the spouses stop talking to one another and communicate only through their attorneys.
Cobert says ADR (Alternative Dispute Resolution) and mediation has grown more popular in recent years as a way to more amicably and cheaply handle divorce disputes. He also recommends the couple consult with a Certified Divorce Financial Analyst who can analyze their assets and circumstances and help them proceed with the separation in a way that makes the best financial sense for both.
“More people are using CDFAs to run the numbers and come up with optional settlements. It’s usually a lot better to try to keep it out of the courts,” he said.