Last month’s blog covered how working with a neutral financial expert as part of a collaborative divorce or mediation provides couples with the flexibility to craft an agreement to meet the current and immediate future needs of their family. This month’s blog offers a few more examples of why divorcing couples might want to go this route.
As a quick review, a neutral financial expert is a finance professional, often a CPA or a financial planner, who has also undergone training on issues particular to divorce and dispute resolution. So even for couples who have worked with a financial professional to prepare their taxes or help them make investment decisions during the marriage, it’s not the same as the neutral financial professional in divorce negotiations.
The benefit of the neutral financial expert really is one of the advantages of opting for collaborative divorce or mediation rather than litigation. In most litigation cases, the financial details usually follow a formula with essentially no room for negotiation. Working with a neutral financial expert as part of a collaborative divorce process or mediation offers flexibility that is often not available in litigation.
An example of this occurred during one of my recent collaborative divorces. The issue at hand was taxes as it pertained to child support and alimony.
During the marriage, one spouse was the primary earner while the other stayed home with their child. In a traditional litigation, the earnings of the one spouse would have been entered in a standard formula for alimony and child support. Since child support is not tax deductible, the primary wage earner would have ended up in the 40 percent tax bracket. That tax burden would then make it difficult for him to make ends meet after paying both child support and alimony.
Working with a neutral financial expert as part of a collaborative divorce, the couple had some flexibility on how to ease the tax burden. After much analysis and examining several options, the expert devised a strategy where the primary wage earner would pay more in alimony—which is tax deductible for him and earnings his spouse would have to declare—and less in child support. It was a “win-win.” The amount paid to the spouse was more than the child support and alimony formulas would have provided (even after taxes) but the cost to the wage earner was less after considering the tax benefits. This provided more money for the care of the children and also freed up money for the wage earner for living expenses, retirement, etc.
While this description may sound fairly straightforward, the analysis required to make this work took the skills of a finance professional with specific training in this area. Yet I think you can see the benefit.
I’ve had many other cases where a neutral financial expert has been the reason for a successful outcome. One comes to mind regarding a divorcing couple that had an enormous amount of credit card debt. While the couple had several 401 (k) and IRA accounts for retirement, none of these accounts individually could pay off the credit card debt. Collectively, it was possible but would result in a 10 percent penalty for early withdrawal.
The financial expert assessed the situation. Noting that one of the spouses was over 59 years old and eligible to withdraw funds from the IRA without penalty, the financial expert devised a strategy where the older spouse withdrew funds to pay off the high-interest credit card debt without penalty and the younger spouse transferred funds from his IRA to the older spouse’s IRA after the divorce, without incurring taxes or penalties. As a result, the financial expert was able to equitably allocate the retirement funds so that both had 50 percent of the total retirement funds after the credit card debt was paid. Most important of all, both could then enter their new lives without paying high interest on credit cards that would greatly impede their being able to cover basic living expenses.
As mentioned before, these types of arrangements would have been very difficult for the aforementioned couples to come up with on their own. Both involve complex budgets, expense analysis and tax projections, as well as exploring/creating a number of financial solutions for the couple to consider. This kind of negotiation required a specialist who not only possessed the expertise, but was a neutral expert working for both of the parties. And like the example cited in the previous blog, I feel confident in saying an agreement like this would be unlikely to occur without a neutral financial expert to run the tax analysis.