Bill and Melinda Gates are ending their marriage after 27 years. While the majority of divorcing couples are not handling a $140 billion estate, there are common lessons learned to avoid discovering hidden drawbacks in your settlement down the road.
Here are four settlement pitfalls to watch for.
#1: House Poor
People do not like being uprooted and often hesitate to inflict change on children who may already be upset from the divorce. Others are seriously attached to their house and likely invested a lot of work in it over the years. Nevertheless, many of the recently divorced ultimately find house payments difficult and the house itself difficult to maintain alone.
Your house may also suddenly be too large and, depending on the situation, can produce a huge and unexpected taxable event such as capital gains when you sell it.
All too often divorcing people focus on short-term issues and benefits rather than considering long-term effects of financial decisions. Some are so eager to end the marriage that they do not even want to discuss the benefits and drawbacks of decisions.
Money decisions amid emotional turmoil almost always come with obvious plusses and hidden, eventual minuses. For example, if you keep the house and the equity but give up some substantially equal amount in a retirement plan account, you risk missing out on investment-return gains in your retirement accounts and lose that amount of savings for your retirement and your future.
If you have to refinance the house to pay some of the equity to your spouse, you may run into cash-flow problems – essentially trading retirement savings for, perhaps, equity in a home that you may ultimately find too expensive to keep.
Always consider the long-term and the likely what-ifs.
#3: Real Costs
Maybe you want to keep that rental property or your favorite investments in the settlement. You are likely looking at the current value of the investment, without considering costs of liquidation.
For example, if you receive the rental property and eventually sell it, you might pay capital gains and depreciation recapture, a sort of past-due for tax breaks you take for wear on the property through years and which can amount to a sizable tax bite. You may also pay realtor fees and general sales expenses.
Always calculate the cost of eventually selling or disposing of an asset that’s part of a marital settlement.
#4: See Only One Piece
A divorce settlement is often a large puzzle with lots of pieces. People commonly look at one or maybe two areas, not the entire picture.
For example, you and your ex can trade the child exemption on your tax returns in different years. Having a child one extra day a year may allow you to claim head of household status when you file income taxes, potentially a considerable saving..
Much like when you decided to divorce in the first place, look at your settlement agreement as a whole. All parts need to work together to help you thrive in the near-term as well as in your future.
Talk to Your Private Banker
Finally, make sure you talk to your Private Banker in order to help you avoid these settlement pitfalls. Your expert can also help ensure your new financial plan is consistent with your new circumstances.