Divorcing clients often struggle to understand the future value of certain assets. A financial expert can help the client (and sometimes, the attorney) to recognize which assets will offer the greatest long-term benefits.
By Nancy Osmond Popovich, Certified Divorce Financial Analyst ®
One of the most common money mistakes that people make during legal settlements, such as divorce, is failing to fully understand what assets may yield in ten or more years down the road. Clients may think that getting to keep the large 401(k) account or the marital home is a win, or that simply splitting things 50/50 is the best way to go. However, because these assets can grow or decline in value over time, it is important for attorneys to understand the long-term impact of these decisions on a client’s overall financial plan and lifestyle. Being able to illustrate the long-term outcome will help to guide clients through the emotional turmoil of divorce and maximize the benefit for their families.
So, how do you determine which assets will be more beneficial for your client in the long-term, and why? Let’s take a look at a few of the biggest marital assets.
Remember that not all retirement accounts are created equal; that’s why it’s so important to have some background in projecting asset growth when making decisions regarding which retirement assets will be most beneficial to your client.
For example, if you have a higher income spouse who is no longer eligible for making Roth IRA contributions, it might be more beneficial to both spouses if the higher wage earner keeps the Roth IRA, as opposed to splitting it straight down the middle. The lower earning spouse may still have an opportunity to make additional contributions, which could provide a greater benefit in the long run.
Roth contributions are tax-free when they are used in retirement, so it would be a more advantageous asset for the higher wage earner to have than, say, an old 401(k), which is pre-tax money. Funds coming out of a 401(k) in retirement would be taxed at that time. Since the higher income spouse likely earns more than the limit to qualify for Roth IRA contributions, it might be worth giving up more pre-tax money (in the form of a 401(k), for example) to the lower earning spouse.
This is just one example; the idea is to get clients to understand that it may be beneficial to give up some taxable funds to gain more tax-free assets, or vice versa, depending on their situation. Either way, splitting things right down the line might not always be the best option for either spouse.
It’s all about helping clients determine which asset is better for their personal situation. The hard part is making the projections and accounting for different ‘what if’ scenarios. However, if you can illustrate to the client what a probable settlement that is fair to both spouses would look like and what it would mean for their future, you may have an easier time settling a case.
For the lower earning spouse, it might be better to take a greater portion of a pension asset because it is a guaranteed income stream for their future. I’ve found that it is sometimes hard for people to wrap their heads around how beneficial that amount of money could be in the future.
When clients are going through a divorce, the 401(k) asset can seem like a big, shiny number that is far greater than what the pension appears to offer at that time. In their emotional state, they may think it is better to keep the 401(k), when in reality the pension asset will serve them better in the long run.
It’s important to get clients to understand that there are very few other guaranteed income streams. Many pensions even come with an annual cost of living increase.
In many cases, one or both of the spouses may want to keep the marital home; and very often, this is not the right move for either spouse. Through the divorce process, you’re essentially taking the resources that were used to run one household and dividing them in a way that is supposed to now support two. More often than not, it simply doesn’t work, financially speaking, to keep the home.
Especially for the lower income spouse, it’s important to realize that getting to keep the house is not the end of the road. The client still needs to save for retirement, but the expense of keeping the house may end up being too much and there may be no money left to save. I’ve seen it happen many times that a client is forced to sell the house a year or two after having fought so hard to keep it during the divorce.
Of course, this can be a very emotional decision and many clients are willing to fight hard to keep the marital home. There’s often a fear of uprooting children from their home and clients tend to get stuck on keeping the house to help with their family’s emotional stability. In reality, home is where your family is and keeping the house when you really can’t afford it is just going to cause bigger problems down the road.
Communicating Reason to an Emotional Client
The key is for attorneys to be able to illustrate what they believe a reasonable settlement might look like. In their emotional state, it can be difficult for clients to recognize what is reasonable; but as their lawyer, you know what is best for your clients. Illustrations help to get emotions out of the way so that the client can focus on the numbers and the future. Laying it all out in black and white may help a lawyer settle a case more easily and with greater benefit to their client.
Nancy Osmond Popovich is a Certified Divorce Financial Analyst, Managing Director and Portfolio Manager with The Wise Investor Group at Robert W. Baird & Co. in Reston, Virginia. www.thewiseinvestorgroup.com.