I hope you never need this post. Divorce hurts, and maybe the last thing we want to do is plan clever financial strategies in the midst of such as emotional situation.
I sat down recently with Justin Miller, “National Wealth Strategist” for BNY Mellon Wealth Management, and what Miller and his team do is help divorcing couples maximize their financial situation, through tax strategies and careful financial planning – specifically tailored for wealthy families.
Why was I meeting with Miller? To answer your question, no, everything is actually great at home. My first wife continues to choose the path of tolerance, despite everything. But thank you for asking. You’ll be the first to know if anything changes.
I met with Miller so that I could bring you some nuggets of financial wisdom in case you or someone you know is headed down the path of divorce.
I first knew Miller was my kind of guy when he referred lovingly to his two children as his darling little “dependency exemptions.”
Two of his big points in particular seem worth noting.
Before getting into specifics, however, Miller urged folks facing divorce to “start early” in financial planning. “This is not something you do after the divorce is finalized,” he cautioned. “This is something to address early in the divorce process.”
The two take-aways from our conversation had to do with retirement account planning and property ownership splits.
Miller began with a big cautionary tale about “beneficiary designations” in “qualified retirement plans.” Just as with everything about talking to specialized tax attorneys like Miller, many words require unpacking. “Beneficiary designation” means “where your money goes if you die.” Qualified retirement plans” means your 401(k) or pension plan. Incidentally IRAs, otherwise similar-ish retirement vehicles, are not regulated under the same employee retirement account rules, so aren’t “qualified” in this same way.
Here’s a big potential problem with qualified plan beneficiary designations: Whenever you opened one of these plans, you took a brief moment to name your beneficiary, which, if you were married or engaged at the time of the account opening, was probably your beloved. After a divorce, however, your beloved may no longer be your top choice, or even your one-hundredth choice, to receive your money. But the weird thing about “qualified” plans is that your money will only go to whoever is your named beneficiary. That beneficiary designation overrides any other will or estate-planning document that exists. Even if you meant your kids, your grandkids, your siblings, or a charity to get your money, and you spelled that out clearly in your will, federal law for qualified plans means the designated beneficiary gets the money. If your ex is on that document, no matter how undeserving, that’s who gets the money.
Here’s the bottom line on Miller’s point: In the midst of a divorce, be sure to update the beneficiary of your pension or 401(k) plan. Otherwise that no-good lying stinker of an ex-spouse could get rich off your negligence.
Miller’s second big tax tip regarding your jointly-owned house may require cooperation with your ex. Your cooperation could be worth a lot of money. Hopefully you already know that you can enjoy tax-free capital gains in the value of your house, up to $250 thousand personally, or $500 thousand with your spouse, under certain conditions.
Let’s add an example to talk about real-life numbers to understand the importance of financial planning of your house sale through the divorce. Let’s say you bought a house 30 years ago for just $200,000. Now, however, the property is worth $1 million. If you sell that property, you could be liable for paying capital gains on the $800,000 difference between purchase and sale price.
Now, obviously you should strongly consider qualifying for the $500,000 capital gains tax exclusion by selling the property while you are together, rather than merely settling for the $250,000 capital gains tax exclusion you’ll get by yourself.
In my example, you’d owe $110,000 all by yourself – based on $550,000 in taxable gains and a 20 percent tax rate. Sell together, however, and you’d only owe $60,000 – based on the $300,000 in taxable capital gains at a 20 percent tax rate.
Bottom line: Save $50,000 by working together, however unpleasant that may be.
Miller points out that if you simply can’t sell while still living together, you may have up to three more years to make the sale and enjoy the full $500,000 tax exemption. Because qualifying for the capital gains tax exclusion requires you both to have lived in the house for just two of the five years prior to sale, you might have up to three years to make the sale, even after you both no longer live in the house.
Finally, here’s an important related note about this capital gains tax exclusion. When divvying up the home value between the two of you, take into account the built-in tax liability of the property. Returning to our home ownership example helps here again. Also, side-note: This next point applies to couples whose house has gone up tremendously in value from when they bought it.
Sometimes in a divorce one spouse buys out the other spouse’s home equity, usually the spouse planning to stay in the house. One dumb way of dividing up our theoretical $1 million house might be that the staying-spouse pays the leaving-spouse $500,000, planning on staying for the next 10 years. While at first blush this appears fair – $500,000 is half the $1 million value – this is dumb because when the staying spouse finally sells, that whole capital gains tax liability comes with the house. Even if the house does not go up in value, 20 percent of the $800,000 gain will be owed in taxes, or in other words $160,000. Even after the $250,000 capital gains exclusion, the staying spouse will owe $110,000. Paying for exactly half the value of the home, with that large liability in the future, makes little sense.
As with any of this, you want to do some careful planning ahead of time to negotiate a fairer split of the house value.
Mostly I hope my first wife continues to look on my faults with indulgence and that you, too, have no need for any of this advice.
A version of this post ran in the San Antonio Express News and Houston Chronicle.
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