In a marriage, there is often one spouse that managed the finances and the family budget. During a divorce, it is important for the spouse that has not paid attention to finances to now get up to speed and pay attention because the financial settlement is not as black and white as it may seem on a spreadsheet. It is important to understand that not all assets are created equal. What follows is a few of the financial definitions you should be acquainted with in order to understand the financial settlement portion of the divorce.
- Liquid Assets – No, we are not talking about liquid gold. This means that an asset can be converted into cash quickly with minimal impact to the priced received. You can look at this asset like cash because their prices are relatively stable when they are sold on the open market. Some examples of liquid assets are: most stocks, money market instruments and government bonds
- Illiquid Assets – So if liquid assets are not actually liquid, then illiquid assets are not gold in solid block form. These assets cannot be easily be sold or exchanged for cash without a substantial loss in value because there may not be as many willing investors or speculators to purchase an asset. Some examples of illiquid assets are: houses, cars, antiques, private company interests, and some types of debt interests.
- Capital Gains – When the value of a capital asset (investment or real estate) increases, the asset now has a higher worth than the purchase price but the gain is not realized until the asset is sold and you can also have a capital loss. A capital gain may be short term (one year or less) or long term (more than one year) and must be claimed on income taxes.
- Marital Home – If one party is keeping the marital home, it is often the case that the property can be transferred “pursuant to a divorce” to avoid property transfer taxes. In the City of Chicago, property transfers pursuant to divorce are not exempt from the real property transfer tax.
If you are going to receive a portion of a retirement account or an entire account is going to be transferred to you, you need to realize that not all retirement accounts are alike, especially when it comes to taxes and liquidity.
- 401(k) – contributions are pre-tax
- ROTH 401(k) – contributions are taxable but qualified distributions are not taxed
- Vesting Requirements – If an employee leaves the company, then he or she may not be entitled to that 401(k) employer match unless he or she has met the employer’s vesting requirements
- ROTH IRA – contributions are taxed but the assets in the account grow tax-free and qualified distributions are not taxed
- Traditional IRA
- Qualified Distribution – distributions made from a Roth IRA that are tax and penalty free. In order to be a qualified distribution, the following two requirements must be met :
- It must occur at least 5 years after the Roth IRA owner established and funded his/her first Roth IRA
- At least one of the following requirements must be met:
- The Roth IRA holder must be at least 59.5 when the distribution occurs
- Distributed assets limited to $10,000 are used towards the purchase or rebuilding of a first home for the Roth IRA holder or qualified family member
- The distribution occurs after the Roth IRA holder becomes disabled
- The assets are distributed to the beneficiary of the Roth IRA holder after his/her death
- Early Distribution – Distribution is the removal of assets from a retirement account, paid to the retirement account owner or beneficiary. The retirement account owner (or beneficiary) may be required to pay income tax on distributions received during the year. Early distribution penalties may also apply if the distribution occurs while the retirement account owner is under the age of 59.5. While distributions can occur at any time, certain requirements must be met before distributions can occur from qualified plans, 457 plans and 403(b) accounts.
Ok, so you have heard of a budget, but have you tried to prepare a budget? Do you know how much you spend on utilities, food, clothing, transportation, etc.? Part of the divorce process involves completing a financial disclosure form, which requires you to put your budget in writing. Many times, a client’s first attempt to prepare the budget is very difficult and usually incorrect. But in a financial settlement, it is really important to think about the assets that you will receive, whether they have liquidity and whether you will be able to live comfortably in your budget. If you plan to keep the marital home, will you be able to afford it with the assets you receive? Is your credit rating good enough to re-finance the mortgage in your name, only?
We never recommend going it alone on a divorce, but if you are going through a divorce and haven’t paid attention to your finances during the marriage, you definitely need someone on your side. We can help!
Make an appointment here NOW or call 312-893-5888.