Preparing for Retirement When You’ve Gone Through a Divorce
No matter your stage in life, divorce is disruptive and will likely wreak havoc on your finances. This includes retirement savings you might have put away during the marriage. Unfortunately, this can be more of a problem the older you are, especially if you are nearing or in retirement.
You’ve moved on from “I do” to “I don’t” and are in the midst of trying to sort out life in the aftermath of what was probably (might still be) among the biggest storms of your life. If contentious and contested, it probably is the biggest emotional and financial storm you’ve face.
If you find yourself in this scenario – given the statistics on divorce, there’s a decent chance you might someday face this if you haven’t already – then you know or are learning this is no laughing matter.
It’s tough emotionally for all involved parties, including your ex, kids and grandkids, even friends the two of you shared, etc. Not the type of experience anyone would wish upon their worst enemy.
Beyond the emotional turmoil, there is the financial messiness…even destruction, depending on the circumstances, concessions, contentiousness of the divorce proceedings and ultimately the final outcome in terms of who pays/gets what. Quite often it is the lawyers who are the only ones to come out of this scenario in good shape.
If this is where you find yourself, or expect to soon, then you have work to do to protect yourself and your financial future. Today we cover some of the key considerations and important steps to take.
What you’re due
Before moving forward with determining what you have to work with post-divorce, you need to take care of the issue of what might be due to you from your ex-spouse, or vice versa, in terms of retirement savings that have been accumulated during the marriage.
This falls under asset division within a divorce proceeding, where the court seeks to provide equity to the parties involved. This can encompass home(s) or property, vehicles, non-retirement savings, bank and other cash accounts, possessions (artwork, jewelry, etc.), and much more. Right down to who gets the pets.
It also involves retirement savings established and accrued within the marriage, as both parties theoretically were involved in the contribution of such assets.
According to the IRS, there are two main legal provisions that pertain when it comes to divorce and qualified retirement assets that need to be split by a court.
- Transfer incident to divorce is an order that is part of a legal separation or divorce agreement used when individual retirement accounts (IRAs) are part of the marital assets to be divided
- Qualified Domestic Relations Order is a legal instrument entered as part of a legal separation or divorce agreement used when qualified employer-sponsored retirement accounts are part of the marital assets to be divided
In the case of savings contributed to a qualified individual retirement account (IRA), while they are considered to be contributed and owned by one person by the IRS, when it comes to divorce a court recognizes that both parties were involved in funding the account.
As such, the IRAs of either/both parties will likely be recognized as part of the marital assets that would be split upon dissolution of the union.
According to the IRS, such an incident is considered a transfer incident to divorce that should be included in the separation or divorce settlement agreement approved by the parties and the court.
In such instance, one party can transfer a portion or the entirety of an account in their name to satisfy the agreement. For example, one party could transfer half of the value of a $50,000 IRA to the other party in a divorce proceeding if the court made that part of the agreement. Depending on how the agreement is worded, this can be considered either a transfer or a rollover from the IRA account.
Importantly, this would not be considered a taxable distribution by the IRS, so there would be no 10-percent penalty for early distribution or tax due. The reason? It would be considered a transfer incident and not a taxable event for the spouse relinquishing part or all of an IRA to the other person as part of a court order.
The same would hold true for the party receiving the proceeds from the IRA. Given this would be considered dividing the marital assets versus taking distribution from a qualified retirement account, taxes and potential penalties would not be due by the receiving party at the time received.
But once they did take a distribution from the account where the proceeds were transferred to or rolled into, the proceeds of such a transaction would be taxable given the funds had not been previously taxed.
It is important to remember that the assets (cash, stocks, bonds, mutual fund shares, etc.) would not be considered qualified, and as such would be ineligible to be placed into an IRA or other qualified account by the recipient, losing the benefit of tax-deferred growth going forward.
One last important note is the fact that a transfer incident to divorce is not automatic, according to the IRS. It has to be requested by one party and agreed upon by both, with approval from the court, in order to avoid the issue of taxation and penalties. The custodians involved from both sides will probably require documentation from the court (in the form of the finalized agreement) in order to play their role in the transfer or rollover.
Employer-Sponsored ERISA Plans:
In the case of savings contributed to an employer-sponsored qualified ERISA Plan (Employer Retirement Income Security Act), the most popular of which can include defined-benefit pension plans, 401(k)s, 403(b)s, SEPs and more, a QDRO is used to divide qualified retirement plan assets between the owner and their current or ex-spouse or children or other dependents.
In the case of a QDRO, one party must request the order from the court in order for it to be included in the separation or divorce agreement – it is not automatic.
Unlike the transfer incident to divorce, a QDRO allows for the proceeds to be rolled over into the recipient’s own qualified employer-sponsored retirement plan, such as a 401(K), or an IRA. Normal distribution rules would apply thereafter. The receiving party can even do so into a Roth IRA, although they will have to pay taxes on the conversion, but with no penalties involved.
Just as with the aforementioned transfer incident, such a transaction would be tax-free as long as it was included in the separation or divorce agreement and properly reported to the IRS and the custodians involved for both parties.
One last item in terms of what you may be due involves Social Security benefits. According to the Social Security Administration, you are eligible for Divorced Spouse Benefits if you are at least 62 years old, have been divorced for at least two years, remain unmarried now, and were married to your ex-spouse for at least 10 years. If such is the case you could be eligible for up to half of your ex’s benefits.
Overall, it’s likely this has all been covered by your divorce counsel, but you want to be certain these legal provisions are included in your separation or divorce agreement. Otherwise you could be left short of what you are due and/or with a potential huge tax bill on top of all your other legal costs. Ouch!
Once you’ve covered the bases in terms of what might be due to you, or what you must give your spouse upon a legal separation or a divorce, it’s time to take a look at what you have left for retirement.
Unfortunately, the picture here might be a bit of a downer.
You’ve probably shared expenses and benefited from combined salaries and savings up to now. With those things changed, it’s likely you’re going to feel a financial pinch when you are left as the sole breadwinner of your household.
Maintaining the same standard of living might not be possible, at least not for some period of time. If you’re already in retirement, this can become permanent unless you really work hard and make good decisions, which will almost inevitably result in some serious belt-tightening for some period.
The takeaway here is to be prepared for another dose of reality that might prove just as unwanted as the actual divorce. Even if the divorce was something best for you (maybe even both parties), going alone, especially the older you are when it happens, is tough for anyone and will take some adjustment.
Bottom line, prepare for the mental and emotional challenges of having less and expect belt tightening for the short and potentially long term.
New reality – new plan
Whether you had a retirement plan in place or not, given what’s occurred, just as with other aspects of your life in terms of new beginnings, you will need a new plan.
From a practical standpoint you are now planning for one person versus two. While many of the same needs, desires and goals may remain your vision for your retirement, you are looking at an entirely different scenario. If such is the case, you’ll be looking at the reality of having to fund that same retirement on your own.
But there is a good chance that what you thought of as your plan wasn’t completely your vision for retirement. In fact, maybe it wasn’t much of your plan at all.
Between compromising on how much you each wanted to travel, or where to live, how much to leave to the kids, selling or keeping the home, etc., things can get confusing in terms of what your desires or dreams actually were…indeed, are!
While planning can be tough, the good news is that you can start anew and determine what your desire for retirement is at this point. The decisions can range from the lifestyle you want to maintain, where you wish to live, travel, spending time and money on kids and grandkids, leaving your estate to family and loves ones, etc.
Creating your own plan can be a good exercise that is empowering – you get to decide. And you get to make it happen.
Now for the sobering part. You will be the one that has to make it happen. That’s where the hard part will come into play. This requires a budget that will help you accomplish what you want in retirement.
For some perspective, it’s worth noting that many experts assert that you’ll need 70- to 80-percent of your pre-retirement income to maintain your current standard of living in retirement.
Given that you’ve separated or divorced, the combined income level you were accustomed to has probably been severely cut…theoretically by as much as half.
As such, when you start the process of creating your new budget, it will be with what you have versus what you had.
If you are still working you should start by listing your current income and expenses. If instead you’ve already retired, you need to list your remaining retirement assets and savings, as well as current expenses.
Expenses you should account for include:
- Transportation (auto, gas, maintenance and repairs)
- Utilities (water, electricity/gas, phone, Internet, etc.)
- Healthcare and associated prescriptions and products
- Insurance (medical, life, auto, home/renter, Long Term Care, etc.)
- Travel (regular – not traveling around the world for six months at a time)
- And more
There’s also the goals and desires in retirement that will have to be funded:
- Extensive travel
- Paying education costs for kids and grandkids
- Charitable giving
- Legacy – passing wealth to family and/or charities
- A disaster fund
- And more
Bolster your income
Given what’s occurred and the fact it’s often more expensive to go it alone, you may need to look for ways to bolster your income before ever considering retirement, even if you have a good salary and benefits.
While still working you may want to take on a second job. We’re not talking about greeting guests at Walmart or working fast food. Remember that you have skills and expertise, so consulting opportunities can be available and very lucrative, even on a part-time basis.
Beyond that, chances are you have the contacts and a built-in network in place to utilize, which can make finding meaningful and financially rewarding work aside from your employer easier. It may even work out to become something you continue after you retire from your current employer.
Speaking of working after you retire, doing so, even part-time, may have to be a reality in order to cover the expenses you expect to incur in retirement.
Even the issue of when you should retire shouldn’t be a sacred cow scenario. Sure, you’d love to do it when you originally planned, say at age 55 or 60. But your reality now is different and the ability to successfully retire when you wanted might not be realistic anymore.
In fact, there’s a good argument in today’s age to continue working longer in retirement if you are able. Beyond health, mental and social benefits, doing so for even a few years reduces the number of years you’ll have to pay yourself in replacing that paycheck you’ve been used to getting every month.
If you do go this route you won’t have to tap your savings during that period, which in turn allows your savings to continue to compound and grow. And reduces the amount of savings you will need in retirement.
There’s also the issue of continuing to receive insurance coverage from your employer if they provide it. Otherwise you’ll pay for it yourself once you retire until you become eligible for Medicare coverage starting at age 65.
Also, remaining at your employer for a longer period allows you to continue contributing to an employer-sponsored plan, thus increasing your retirement savings before you walk out the door for the last time. Additionally, if your employer offers matching on your contributions each year, that’s even more you will potentially have in qualified savings when you do retire.
What you’ll have
Looking forward beyond what you have now, especially while still working, you need to examine all sources of income you will have to draw on during retirement. If you are already retired, this is what you have to work with now.
This can include retirement savings, Social Security (available starting at age 62, but often better to delay), cash from non-qualified accounts (checking and savings, brokerage accounts, CDs, annuities, etc.), rental and passive income, inheritance you might be expecting, and all other sources of money or assets you realistically expect to be able to count on for your retirement.
To ensure you have lifetime income you can’t outlive, you may want to include an annuity if you don’t already have one.
In looking at your income in terms of budget and planning, you definitely want think big picture, which includes two key questions:
- What will you be able to count on when you do retire?
- Will that amount enable you to fund the retirement you envision for yourself?
Obviously if the answer to the second question is no, you will have to determine where you’ll compromise in terms of what your retirement vision will be going forward.
While that may not be the news you want to hear, having gone through the exercise of examining everything and creating a budget that takes into consideration your actual expenses and sources of income, it will be easier to decide where you want to adjust your plan going forward. And it will be your informed decisions versus those of a court or someone else.
You know for yourself already that life throws you curveballs, and in the scheme of things divorce or a legal separation are among the toughest challenges we can face.
The emotional toll can be devastating…at least for a period. As can be the financial damage inflicted both short and potentially long term. This can be especially true when it comes to your retirement savings and plans, depending on how close you are to the day you retire.
Such disruption can cause disconnections in your life, with family, friends and even yourself. It can also disconnect you from your money and finances – something you can’t afford to let happen given there can be serious and lasting consequences if you do so.
The good news is just as with anything else, how you deal with a situation can make all the difference in the world, no matter how devastating it might have been in the moment. You can get past this and secure your financial security and future by taking informed steps.
And there is help, which you should definitely enlist.
Here at Oak Harvest we can assist you with this, helping you reconnect with your money and finances. We can advise you as to your options.
We can help you create a holistic, comprehensive retirement plan addressing relevant issues, utilizing strategies that cover taxes, income, spending, social security, healthcare, LTC, legacy, and more, customized to your specific scenario and needs.
A plan created with the goal of ensuring you have the best opportunity of living out the retirement you envision.
Let Us Help You Achieve the Retirement You Deserve!
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