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Safe Harbor

By Diana Shepherd on December 09, 2011

Here's help navigating the financial dangers of divorce so you will reach safe harbor: a financially sound future.

While you were married, you and your spouse were co-owners of a “business”: your marriage. Like any business owners, you accumulated both assets and liabilities. Maybe you bought a house, a car, a cottage, some furniture. One or both of you earned income, maybe put some money aside for retirement. In addition to mortgage and car loans, you might also have accumulated some credit-card debt. Maybe one or both of you had a bad year – you got sick, or your spouse was laid off – and your financial troubles were the final straw in an already troubled relationship.

Whatever your own reasons were for ending your marriage, money is going to play a big part in your divorce process. Since property division on divorce is a state or provincial matter, there are regional differences when it comes to dividing the marital pie. You’ll need to ask your lawyer about the rules governing property division in your area, but here are some general rules to get you started.

Marital vs. Separate Property

The first thing to know is that there are two kinds of property: Marital and Separate. Anything that is marital will go into the marital pie that’s going to be divided; anything that’s separate property will not. The distinction between the two is a gray area and should be discussed with your lawyer, but here’s how most courts typically define separate property.

Separate property is anything that was gifted during the marriage, inherited during the marriage, or brought into the marriage and kept in either spouse’s separate name. Let’s take a look at some examples. Karen got married 10 years ago. She was in love, so she told her husband Frank: “What’s mine is yours and what’s yours is mine.” So she changed the title on her cottage from her name alone to both of their names. Even if her husband never contributed a dime to the upkeep or maintenance of the cottage, in most areas, the cottage will likely be part the marital pie and up for division now that they’re getting divorced.

How about the inheritance that Karen received five years ago from her Aunt Millie? She left it in a bank account in her separate name, which means that the money she inherited is her separate property and not up for division. But what if Karen had taken her $15,000 inheritance and used it to renovate the kitchen in the marital home? She could ask her lawyer to try to subtract $15,000 from the marital portion, but the courts are likely to rule that the inheritance became marital property when she invested it in the home. As a general rule, you can convert separate property into marital property by commingling it (e.g., if Karen had put the inheritance into a joint account with Frank rather than one in her name only), or by making a “presumptive gift to the marriage” (e.g., using the inheritance money to renovate the kitchen, or to take the family on a ski trip to Switzerland, or to buy a motor-boat that the family all enjoyed at the cottage).

Here’s another tricky part: any increase in value on the inheritance (or any other separate property) is considered marital in most areas. Aunt Millie left Karen $15,000, which grew to $20,000 at the time of her divorce. The $5,000 in growth could be considered marital, depending on state or provincial law.

Let’s look at one more example. Let’s say Karen was the saver in the family, and during her marriage, she automatically deducted $100 from each paycheck and placed it in a high-interest account in her separate name. Do you think the money in that account is marital or separate property? It’s marital property, because everything Karen earned during her marriage is marital property regardless of whose name is on the account. The general rule is that everything that either of you earned, purchased, received, or saved during your marriage is marital property, which must be divided with your spouse when you divorce.

The Marital Home

In many divorces, the biggest question is who gets the marital home. Should the wife get it, should the husband, or should they sell it and split the proceeds? What if the house is “underwater” – meaning that the householders owe more on their mortgages than their houses are worth? The answer is not always easy or clear.

In a normal economy, couples typically build equity in their homes; if they decide to divorce, they would usually divide the equity they had built by selling the house or by one partner buying out the other’s share. But after the recent boom-and-bust cycle, many couples own houses that neither spouse can afford to maintain on his/her own, and that they cannot sell for what they owe.

So with the housing market still struggling in may areas, one of a couple's biggest assets can be a liability if they're breaking up. Some divorcing couples are being forced to ask themselves a new question: “Should we stay together for the sake of the house?”

Before the recession, there were generally two main options for the home:

  1. One spouse stays in the house (with the children, if any) and buys the other spouse’s share.
  2. The spouses sell the house during or after the divorce process and split the proceeds.

Now, let’s look at today’s reality.

In a recent survey of Certified Divorce Financial Analyst® (CDFA®) professionals across the US and Canada, 67% of respondents stated that the current housing market has forced them to come up with creative solutions to property-division problems when the matrimonial home fails to sell – or would sell for less than what clients still owe on the mortgage. The most common solution is for ex-spouses to retain joint ownership and continue to live in the house (often, he moves into the basement and she lives upstairs) until the market improves, agreeing to postpone final division of assets until after the house is sold. Other common solutions include:

  • Renting the house to a third party until the house can sell for more than the debt.
  • One ex-spouse stays in the house until the market improves.
  • ”Birdnesting”. The ex-spouses retain joint ownership of the home, they rent a small apartment nearby, and each one alternates living in the house with the kids and in the apartment on his/her own.
  • One ex-spouse stays in the house and pays rent to the other until the market improves.
  • Structure two levels of spousal support: before and after the house sells.
  • Agree to sell the home at a loss, share the loss, and move on with their lives.
  • Short-sale, foreclosure, or bankruptcy.

If you and your spouse have agreed to continue to own the house together for a period of time post-divorce – for instance, until your children reach a certain age, or until the market recovers and they can at least break-even on the sale of your home – but only one of you is going to continue to live in the home, then you’ll have to negotiate who pays for what until the house is sold. In many cases, the person who remains in the home pays the mortgage and taxes and may get some credit for any reduction in principal on the mortgage from the date of the divorce until the date that the home is sold. If the mortgage payment is similar to what the other person has to pay in rent, then they might agree that the person who stays in the home gets no credit for reducing the principal since he/she is enjoying the benefits of living in the home. Major repairs are usually divided between the parties – either at the time of the repair, or by reimbursing the person who has paid for the repair over time or when the house is sold.

Hopelessly Devoted

Sometimes, people (mostly women) are determined to stay in the marital home no matter what. It’s the place where their children were born; they decorated it with loving care over the years; it represents security and familiarity in the rapidly-shifting landscape of divorce. In some cases, keeping the home can be a big mistake – and sometimes, this mistake can lead to financial ruin. We’ve seen people willing to give up their share in their spouse’s pension, joint investments, or savings accounts in order to keep the house. But if you can’t afford to cover the mortgage, taxes, repairs, and maintenance on your own – without dipping into your savings or retirement accounts – then keeping the home may be a decision you’ll come to regret. Talk to your CDFA® professional about what your financial future will look like if you keep or if you sell the home before making your final decision.

Create a Budget

It is absolutely crucial to develop a realistic post-divorce budget so you’ll know what you need – and whether the property division and spousal or child support payments (if any) will cover these needs. To do this, you’ll need to determine the incomes and expenses of both you and your spouse and also try to estimate what both of your expenses will be after the divorce is final. This is a difficult task for many people – especially if you were not the spouse who handled the family finances while you were married. A CDFA professional can help you to develop a budget and figure out your cash-flow needs – and also let you know if you’re steering towards financial security or disaster. Working with a CDFA allows you to see both the short-term and long-term financial effects of accepting “Settlement A” vs. “Settlement B”, which will help you to make better decisions at a difficult time.

What about my stuff?

We appreciate that you may be attached to certain possessions, but please don’t spend thousands of dollars fighting over “stuff” that has more sentimental than real value! People often overestimate the value of appliances, furniture, and other household items. You should take a look at classified ads on websites such as Craigslist.com or Kijiji.com, or in your local newspaper to get an idea of the dollar-value attached to certain items. In most instances, the family treasures are simply used goods, and they will command little more than garage-sale prices. You can choose to have potentially more valuable items – such as a Chippendale desk or a Tiffany lamp – professionally appraised. Be aware, however, that even a professional appraisal is unlikely to produce numbers that approach replacement values for insurance purposes. Items such as collectables, favorite home furnishings (from chairs to rugs to pots and pans), hobby equipment, and other personal property should not become the focus of your negotiations. A good lawyer and/or financial advisor can help you gain perspective on these items and focus on the big picture when you’re getting ready to negotiate a settlement. Remember that an expensive television or computer has almost no value a few years after you made that big-ticket purchase. The courts don’t look at replacement value but the actual value of the item, which, in the case of used furniture, is often garage-sale prices.

What do you want – and why?

You must have a game plan when you enter into settlement negotiations. Do you know what you want? Do you know what you need? Are you thinking about all options? Are you being realistic in your demands? It is standard negotiating practice to ask for more than you expect to receive – without going to extremes. Don’t be a doormat, but don’t be excessively greedy, either. Insoluble disagreements arise when divorcing couples are negotiating based on wants rather than needs. So take the time to objectively determine your own needs – and those of your spouse – before starting to negotiate. We have found over the years that if your demands are reasonable and based more on needs than wants, then the chances for a quick, fair settlement are good. There must be give-and-take and wiggle-room in your settlement proposals; your lawyer and financial advisor can help you strategize and come up with different game plans and scenarios as you prepare for this negotiation.

The bottom line

You must be well represented and advised in order to negotiate effectively. This includes knowing the “ingredients” of the marital pie, and also how much of that pie you can realistically expect to keep as you prepare to negotiate your settlement.

A team consisting of a lawyer and a CDFA® – and perhaps a therapist if emotional issues are getting in your way – can help understand your needs, your rights, and your true “bottom line” before you sit down to negotiate with your spouse.

Divorce is one of the most difficult and stressful experiences you’ll ever have. During this emotional time, it can be hard to think clearly or rationally, so make sure to enlist the help of professionals who can guide you when you’ve lost your way.

Remember, if both sides are somewhat unhappy with the outcome, then the negotiations went well.