By Ilene Amiel
Divorce is a stressful time. It’s hard to think clearly and be organized when your life is turning upside down. Once you decide to divorce, you begin a process new to you. I tell my clients that getting divorced is like playing a board game that doesn’t come with instructions. You’re not sure what to do, how the game works, what the rules are and how to win (or not lose).
You hire a lawyer or mediator and hope that he/she will help you get a fair settlement. From a legal standpoint, you may be in good shape. But from a financial standpoint, you really need to understand the game. Not understanding your finances can cost you a lot of money and affect you and your children for the rest of your life.
The five biggest mistakes that people make involve budgeting, taxes, medical insurance and credit score management. Here they are:
1. Underestimating Budgets
The most important documents that you will be required to prepare are the Financial Affidavit aka Statement of Net Worth and a monthly budget. Your attorney can help you put them together but, ultimately, it’s up to you to provide accurate and complete information in each category; these will be the basis for negotiations and for the courts. The challenge is to create detailed financial documents based on dozens of line items to properly reflect your assets, liabilities and monthly expenses.
You must include every single expense even if it occurs only once or twice a year. Unexpected expenditures that arise such as appliance, home or car repairs along with unforeseen medical expenses have to be included. Although the Statement of Net Worth and budget can be revised, once you have submitted your final documents, your lawyers will use them to negotiate a settlement. If you underestimate your monthly expenses, you will have to deal with it once the divorce is completed.
2. Misunderstanding Marital Status on Tax Returns
If you’re in the middle of a divorce on December 31, and you both agree to the filing, you can file a joint return. However, once the divorce is final, the IRS considers you divorced for the entire year. You must file as single or head of household (if you have custody of the children). The reason this is important is that generally filing jointly provides the most beneficial tax outcome for most couples. If one of the spouses owes taxes, it could be considered a marital liability. I highly recommend that you consult with your CPA or tax preparer. He/she can review your previous returns and evaluate the current situation to choose the best financial option.
3. Forgetting about a Maintenance Tax
The second issue that is often forgotten is tax on maintenance (aka alimony or marital support). Maintenance is taxable as income to the recipient and tax deductible for the payor. Many people neglect to save a percent of their monthly payment for taxes and then need to come up with a large payment on April 15. You do have a choice and for some couples, the tax consequences are more favorable if they make payments nondeductible and nontaxable because of tax consequences.
Taxes are an ongoing obligation and need to be planned for during the year.
4. Inadequately Researching Medical Insurance
Once your divorce is final, each spouse will be responsible for their own medical insurance. For those individuals whose spouse was insured by an employer sponsored plan, COBRA allows for you to stay on the same plan as you had when while married for three years post divorce. With the costs of insurance changing constantly, it is best to research the options before the divorce is final in order to determine the most cost effective plan to meet your needs.
5. Failing to Check Credit Rating
And now, the last but not least most important mistake that divorcing individuals make: not checking and understanding their credit rating.
Your credit rating is used to determine what rates you can get on loans, lines of credit, car leases and credit cards. While you were married, anything in a joint account or jointly owned will be reflected on your individual credit report and score. Before your divorce is complete, you should get a copy of your credit score and report from all three reporting bureaus–Experian, Equifax and Trans Union. If your credit score is low or contains errors, now is the time to fix it. If you have late payments on your report, they can remain on there for seven years.
You need to fix these mistakes on the reports and learn how to improve your score so you will have the highest rating possible as you move from a married person to a single person with your own identity.
Ilene Amiel is a CDFA (Certified Divorce Financial Analyst) who helps divorcing individuals with the financial aspects of their divorces. For more information about Ilene, please visit divorcefinancialconsultant.com or call (914) 980-0898.