Once a judgment of divorce is granted, assets are retitled and/or transferred according to the settlement agreement. It is essential in taxable (investment) accounts that the tax basis is taken into consideration and recorded with the transfer of the assets. This is imperative for tax purposes, because when those investments are sold, any capital gain or loss must be reported. In tax-deferred accounts, you don't need to worry about the tax basis, assuming that there have not been any after-tax contributions included in the account. These accounts include 401k, 403b, IRA, etc. Do not take withdrawals from these types of accounts until you are at least 59-and-a-half to avoid a 10 percent penalty for early withdrawals (some exceptions may apply). Money taken from these types of accounts as a distribution is considered taxable income and is taxed as ordinary income. You should consult with a tax adviser to determine your tax situation. Also, keep in mind that your marital status at the end of the year determines your filing status.
For persons granted alimony, the recipient must claim this income as earned income, and the payer can deduct alimony on his or her tax return. Be aware that if alimony is the individual's only source of earned income, he or she may need to make estimated payments to the IRS to avoid penalties. When creating a budget, take into consideration that the alimony received is a gross amount. Child support, on the other hand, is not taxable to the recipient, nor is it tax-deductible to the payer. Let's not forget about Social Security income benefits. There are special rules for Social Security. People who have paid into the system can claim benefits as early as age 62 or wait until full retirement age. If, however, the individual was married for at least 10 years and has not remarried, he or she can claim spousal benefits on his or her record, if they are higher than the person's benefits typically 50 percent at full retirement age.
Besides creating a budget, you should make sure that you establish an emergency fund that consists of six months to a year of living expenses. This fund should be kept in a liquid investment such as a savings or money market account. Next, talk to your financial adviser about your needs, goals and aspirations. Request he or she develops a retirement plan for your new circumstances. Let him or her know the specifics of the divorce settlement so that he or she is able to determine if current income will need to be generated from your new investment portfolio. Don't forget to revisit that to-do list you put together with your attorney. Make sure you change your beneficiaries and re-title any assets that need to be changed and apply for medical coverage if you were covered on your spouse's policy. Update your will to have it reflect your new situation and your objectives in the event of your death. If you don't have a will, have one drafted so that your assets will be distributed to your heirs based on your intentions.
No one gets married with the goal of getting divorced. Divorce happens and it is happening more often than ever. It can be agonizing and overwhelming, but with a little handholding, good advice and guidance from advisers, you will make it through. The goal here is to reduce some of the uncertainty of your future, at least financially.
Beth D. Lynch is an investment relationship manager at Schneider Downs Wealth Management Advisors in Pittsburgh. She provides comprehensive financial planning services for individuals and families, with particular experience in cash-flow analysis, retirement planning, investment portfolio development and analysis, and estate tax planning. She can be reached at 412-697-5361 or at email@example.com.