Dividing property can be one of the most challenging and complex pieces of a divorce. What appears to be an easy decision such as “I want the house, you keep the retirement account,” may in the end deliver a settlement nobody bargained for.
Peggy and Mike are getting divorced and they are both age 64. They have two assets: an IRA worth $180,000 and a money market account worth $180,000. Peggy was really concerned about retirement and wanted to take the IRA, as it provided a sense of security.
After the divorce, they each wanted to buy a house. For his down payment, Mike took $90,000 out of his money market fund. Meanwhile, Peggy withdrew $90,000 from her IRA to make her down payment. But because Peggy was withdrawing monies from an IRA, her distribution was subject to income taxes. Therefore, after paying nearly $30,000 in estimated taxes, Peggy only realized $60,000. During the divorce process, Peggy had not been counseled on the potential issues of only taking the IRA. That shortsighted decision ultimately left Peggy less financially secure.
Remember, you cannot equally compare a cash account with a retirement fund because of the tax issues. It seems like an issue that’s easy to avoid, but in reality, most people engaged in the divorce process ignore it. Oftentimes, when crafting a financial settlement people want to see the retail value of each asset, when in reality, it’s extremely important to also look at the after-tax value. Having a clear understanding of how assets work is an integral piece of divorce planning, and thus will allow clients to make the best decisions for their financial future.