Financial Planning for Divorced Individuals

Article excerpt

Don't forget the planning options after divorce.

In Brief

Lots to Do

Financial planning for divorced individuals is a special challenge. Very often, planners don't arrive on the scene until after a settlement has been finalized. Even though it is better for planning to be done before and during the agreement phase, there are always opportunities for and significant benefits from financial planning.

It is likely that the planner will need to work closely with other professionals, such as attorneys, insurance agents, investment advisors, and perhaps even psychological counselors. These specialists may not be aware of many of the financial and tax implications of divorce. The CPA, in the role of financial planner, can provide valuable advice in this area.

The authors present a comprehensive picture of the options available to the planner who comes in after the divorce is finalized. There are various aspects to be considered, such as tax issues, cash management, educational funding, insurance coverage, and retirement planning.

Many articles have discussed planning for divorce and the role of the CPA in structuring alimony, child support, and property settlement agreements. Additionally, the AICPA's Personal Financial Planning Division has published a guide to planning for divorce. While it is ideal for the CPA to be involved in the process prior to the agreement, this is not always possible. For example, oftentimes a new client who is recently (or not so recently) divorced requests financial planning services after all agreements have been finalized or during the late stages of the process. The financial and tax planning needs of an individual after the divorce is complete offer special challenges. Divorced individuals face unique issues when addressing financial needs such as retirement and educational funding. Furthermore, cash management often becomes more difficult after a divorce. For example, the amount of alimony is generally determined based upon the standard of living that existed before the divorce. While this is a noble goal, it is virtually impossible to attain. After a divorce, two households need to be maintained instead of one. This is generally the most significant factor that impacts all areas of financial planning from current cash management to retirement planning.

Tax Planning After Divorce

The tax consequences for both of the newly divorced individuals are highly significant. The divorce instrument should specify whether any transfer payments between spouses constitute alimony, child support, or a division of property. The division of marital property among former spouses has no immediate income tax consequences (i.e., no gain or loss is recognized, and the adjusted bases of the assets carry over to the recipient spouse). Child support payments are also not taxable to the recipient and are not deductible by the payor spouse. Conversely, transfer payments that qualify as alimony are deductible by the payor spouse (for adjusted gross income) and are included in the gross income of the recipient (IRC sections 71 and 215).

Alimony Payments

If the divorce agreement has not yet been completed, a primary tax-planning objective should be to minimize the combined liabilities for both individuals. If the payor spouse has a higher marginal rate, transfer payments that might otherwise be designated as child support or a property settlement may be structured as alimony so as to achieve overall income tax savings. Additionally, the structuring of divorce-- related transfer payments as alimony may reduce the phaseout of itemized deductions or personal and dependency exemptions for the payor spouse. A portion of tax savings can be shared by increasing the transfer payments to the lower bracket former spouse.

Example: George and Mary Jones are divorced in 1997. George pays $40,000 in alimony to Mary in 1998. Under the divorce agreement, he is entitled to the dependency exemptions for their three children. …