A little knowledge can go a long way to making sure you don’t make a big mistake in your divorce settlement. Whether you are using the collaborative process, mediation or litigation, understanding the following basic financial concepts will help you move more confidently into the next stage of your life.
Taxes play an important role in your settlement because not all assets you divide are taxed equally. Some incur income tax, and some incur a more favorable capital gains tax. Capital assets in an investment account, such as stocks or bonds, or real estate are taxed at a maximum rate of 20% and potentially may have no tax at all. This is quite different from retirement assets in an IRA or 401K, for example. These retirement assets incur ordinary income tax from 10% all the way up to 37%. Additionally, retirement assets also can incur a 10% penalty tax if withdrawn prior to age 59 ½. So, a $50,000 investment account and a $50,000 retirement account are not the same.
Many couples don’t consider their home (primary residence) as an investment asset, but for tax purposes it is. Under current law, each individual is allowed to deduct $250,000 of gain on their home when it is sold. For a married couple, that equates to $500,000 of gain. However, if you negotiate to keep the house and give away other investments or retirement assets, you could be subjecting yourself to a substantial gain when it is sold. Since you will now only have one $250,000 deduction to apply to the home’s gain, a substantial tax could be incurred.
Not all assets are the same. Taxes, liquidity needs, and time horizons all need to be taken into consideration prior to dividing your assets. Knowing the financial implications before your divorce is final will help you avoid mistakes you’ll regret the rest of your life.