Five Key Areas Where Divorcees Make Mistakes

We learn at an early age that we all make mistakes and no one is perfect. And while that does ring true, there are certain instances in life when minimizing mistakes is particularly important. One of those instances is divorce. Unfortunately, the missteps people make throughout the process often come back to haunt them post-settlement. That begs the question, what are some common mistakes people make during the divorce process – and how do the smart and savvy avoid them?

Separating finances is a large part of the divorce process. To break it down, we will explore common blunders in five areas: lifestyle, taxes, the family home, legalities, and insurance.

1. Lifestyle

Divorce often brings significant financial changes. In some cases, this makes it difficult to maintain the same lifestyle as before. Few couples easily live on just half their previous income—especially when supporting two separate households and a divided investment portfolio. The wise recognize this early and adjust their expectations realistically for the next chapter.

It is important to have an accurate picture of your expenses. It may seem easy at first to scale back and bring costs down, but if you are not accustomed to living on a budget, it will take some time to build that muscle. You will need to get your bearings and learn what you truly need to live on and, as a result, what you can cut out.

If you have children, it could also be smart to discuss with them how the finances may change going forward. Of course, this conversation varies based on the age of your kids. Children are more impacted by uncertainty or excessive indulgence than by a change in lifestyle. Clear, honest conversations about financial adjustments can help them feel secure and prepared for the future.

2. Taxes

Because taxes are very complex, to avoid mistakes in this category, it is sensible to enlist the help of professionals. A great attorney, financial planner, and accountant round out a team that can likely help you dodge any of the following common pitfalls.

Throughout your property settlement negotiation, bear in mind that not all assets that have the same value on a statement are worth the same. This is because assets like retirement accounts (for example, employer-sponsored 401(k)s or individual retirement accounts) are taxed differently than after-tax brokerage accounts.

With a tax-deferred retirement accounts like a traditional 401(k), any dollars contributed grow tax-deferred until withdrawn, at which point they are taxed like employment income (current marginal brackets range from 10%-37% based on taxable income). In contrast, any dollars contributed to a brokerage account are contributed on an after-tax basis and are subject to preferential capital gains tax (currently 0%, 15%, or 20% based on adjusted gross income) upon withdrawal if they are held for more than one year. 

Additionally, if a security is sold for less than it was purchased for in an after-tax brokerage account, a capital loss[1] is realized. To the extent there are no capital gains to offset capital losses, the IRS allows a $3,000 deduction from ordinary income and for any additional losses to be carried forward into future tax years. When going through a divorce, you should always confirm if any capital loss carryforwards apply – and, more importantly, specify how those losses will be split between you and your former spouse in your agreement.

3. The family home

A common mistake is keeping an expensive home because there are emotional ties or a fear that relocating will have an adverse effect on the kids. Houses can be acceptable low-returning financial assets if you can afford the mortgage, taxes and upkeep, which are typically higher than people estimate. It is unlikely your home will appreciate as much as an investment portfolio, and it is also much less liquid, so weigh the trade-off and opportunity cost carefully.

Another common misstep when considering the family home is agreeing to refinance your mortgage immediately. Your creditworthiness will now be based on your financial strength alone. If your regular source of income is from a former spouse you will likely need to receive six months of spousal support and/or child support before using that as an income stream to qualify for a mortgage. You will also likely need to show you will be receiving the same amount for at least three years past your closing date.

Besides the timeline issues, mortgage rates may be higher now than when your mortgage originated. While it won’t work in every case (especially in high-conflict divorces), keeping the mortgage as-is may provide smart cost savings and could be worth negotiating into your settlement.

4. Legal decisions

If you or your ex have an employer-sponsored retirement plan that is split pursuant to the divorce, not many people realize there is a separate legal process after the divorce is finalized to divide these accounts. A Qualified Domestic Relations Order (QDRO) grants you the right to part of the retirement benefits your spouse may have earned in an employer-sponsored retirement plan. It is critical that your QDRO is executed properly, that it is written according to the specific company’s plan requirements and implemented as soon as possible. Surprisingly, some people wait until retirement to find out the QDRO was not executed properly, so their former spouse keeps the benefits, and they do not receive what they thought they were entitled to.

Another legal process that is important to address is your estate plan. Not updating beneficiaries and key documents post-divorce can be a huge mistake. Post-divorce, the decision makers you want involved and your entire estate will likely be different, so it is wise to consult an estate planning attorney to make sure you understand the legal plans outlining how your assets pass if something happens to you before the divorce is final. 

Many people change their healthcare and financial powers of attorney during the divorce process. However, it is a good idea to check with your divorce attorney before changing any documents to see what impact it may have on your divorce negotiations. If you don’t update your beneficiaries once your divorce is finalized, your former spouse could still receive benefits upon your death, even if that is not aligned with your intent.

5. Insurance

Divorcing individuals often overlook the importance of ensuring that spousal and child support payments are protected by insurance in case of the payor’s death or disability. Ideally, the recipient would own a life and disability insurance policy on the payor, but this does not always happen, due to cost, complexity, and lack of legal requirements.

The recipient should confirm that any insurance policy agreed to be kept in place is still in force annually and that they are the named beneficiary. If you do not have easy access to this information, there will often be stipulations in your agreement for it to be provided at least annually by your former spouse. Be aware that even if your former spouse is supposed to maintain insurance, if the policy lapses, the insurance company will not pay out benefits to you.

In a divorce, financial mistakes are easy to make. Creating a dedicated team to guide you around these common pitfalls will help you reach a strong settlement and enter your next chapter with confidence.  There may still be instances where things do not go according to plan, but minimizing the big blunders will set you on the smoothest path possible. 

¹ https://www.irs.gov/taxtopics/tc409

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