How Does Divorce Affect Your Personal Finances?

Divorce is a significant financial event, requiring a restructuring of an individual’s financial life. It involves disentangling assets, liabilities, and income streams accumulated during the marriage. Careful consideration of these components is needed, as decisions made will shape future financial stability and independence.

Division of Marital Property

Property division in divorce focuses on assets accumulated during marriage. State laws categorize property as marital or separate. Marital property includes assets acquired by either spouse from marriage until separation or divorce. Separate property encompasses assets owned before marriage, or received individually as a gift or inheritance, if kept distinct.

Marital property division follows two legal frameworks: equitable distribution and community property. Most states use equitable distribution, aiming for a fair, but not necessarily equal, division of assets and debts. Factors include marriage length, age and health, earning capacities, and contributions. A smaller number of states use community property laws, dividing marital assets and debts equally, often 50/50. This approach presumes equal ownership interest in all property acquired during marriage.

Marital property includes:
Real estate: The marital home, vacation properties, or investment properties.
Financial accounts: Savings, checking, brokerage accounts, and certificates of deposit.
Retirement accounts: 401(k)s, 403(b)s, IRAs, pensions, and other plans accumulated during marriage.
Business interests: Ownership stakes in companies, partnerships, or sole proprietorships.
Stock options and restricted stock units (RSUs): Acquired during marriage, even if unvested, depending on grant terms and state law.
Tangible personal property: Vehicles, furniture, artwork, jewelry, and other household goods.

Asset valuation is important for property division. Real estate may need professional appraisals. Businesses often require a valuation expert to assess worth. Valuing unique or illiquid items can present challenges. Retirement accounts are valued based on balance or present value, often requiring plan administrator statements.

Dividing retirement accounts often requires a Qualified Domestic Relations Order (QDRO). A QDRO is a court order instructing a retirement plan administrator to pay a portion of benefits to a former spouse, ensuring division without immediate tax penalties.

Allocation of Marital Debts

Divorce divides both assets and liabilities acquired during marriage. These obligations, called marital debts, are distinguished from separate debts. Marital debt includes obligations incurred by either spouse during marriage for family benefit. Separate debt refers to obligations incurred before marriage, individually for non-marital purposes, or excluded by prenuptial agreements.

Common marital debts include:
Mortgages: On the marital home or other jointly owned real estate.
Auto loans: For vehicles acquired during marriage.
Credit card debt: For accounts opened and used during marriage.
Personal loans: Taken out by either spouse during marriage for family benefit.
Student loans: Complex; those incurred before marriage are separate, but those taken out during marriage for family benefit may be marital debt.

An important consideration is that a divorce decree assigning debt to one spouse does not automatically release the other from liability to the original creditor. Creditors can pursue payment from either party if both are signatories, even if the divorce order assigns responsibility. A defaulting spouse could leave the other legally obligated to pay the entire balance.

To mitigate this, spouses can reassign or refinance debts. Refinancing a mortgage or car loan into the retaining spouse’s name removes the other’s liability. Consolidating joint credit card debt into a new account solely in one spouse’s name also separates obligations. These actions require cooperation and lender approval.

Spousal Financial Support

Spousal support, or alimony, is a monetary payment from one spouse to the other after divorce. Its primary purpose is to help a lower-earning spouse achieve financial independence or maintain a similar standard of living, especially after a long-term marriage. It prevents undue financial hardship for one spouse while the other maintains income and assets.

Factors determining spousal support amount and duration include:
Length of the marriage: Longer marriages are more likely to result in awards.
Earning capacity: Includes education, skills, and employment history of each spouse.
Age and health: Influence ability to work and earn income.
Standard of living: Established during the marriage, aiming for the receiving spouse to maintain a comparable lifestyle.
Contributions to the marriage: Both monetary and non-monetary, such as career support or homemaking.
Financial needs: Of the spouse seeking support.
Ability to pay: Of the other spouse.

Spousal support forms include:
Temporary support: Awarded during divorce proceedings to maintain financial status quo.
Rehabilitative support: Provides assistance for a specific period to allow the recipient to become self-supporting through education or training.
Permanent support: Less common, awarded in long-term marriages if one spouse is unlikely to become self-sufficient due to age or health.
Lump-sum alimony: A single, one-time payment instead of ongoing installments, offering immediate resources and a clean break.

Spousal support orders are modifiable under certain circumstances, reflecting changes in either party’s financial situation. A change in income, such as job loss or increased earnings, can warrant review and adjustment. Remarriage of the recipient typically terminates obligations.

Child Financial Support

Child support consists of regular payments from one parent to the other to cover child-rearing costs after divorce or separation. Its primary objective is to ensure children receive adequate financial resources for their well-being, regardless of parental marital status. This legally mandated support is considered the child’s right, not the parent’s.

Child support calculations use state-specific guidelines or formulas, which vary across jurisdictions. These guidelines provide a consistent approach to determining obligations based on financial factors. Most states use either an “income shares” model or a “percentage of obligor’s income” model.

Common factors considered include the gross or net income of both parents, the number of children requiring support, and the custody arrangement, specifically the amount of time each parent spends with the children.

Support orders may include additional expenses for healthcare costs (medical, dental, and vision insurance premiums, plus uninsured medical expenses), childcare expenses incurred due to a parent’s work or education, and special needs (expenses for therapy, specialized education, or ongoing medical care).

Child support obligations continue until a child reaches the age of majority (18 in most states) or graduates high school. Some states extend support for college or vocational school, or for children with disabilities. Child support orders can be modified with a change in circumstances, such as income changes, custody changes, or extraordinary medical needs. Modifications require a court petition and evidence.

Tax Implications of Divorce

Divorce alters an individual’s tax situation, affecting filing status and financial transfers. After divorce, individuals can no longer file as “married filing jointly” or “married filing separately.” They must choose “single,” “head of household,” or “qualifying widow(er) with dependent child” if criteria are met. “Head of household” offers a more favorable tax bracket and higher standard deduction than “single,” but requires supporting a qualifying child or dependent and paying over half the home’s maintenance cost.

Spousal support tax treatment changed for agreements executed after December 31, 2018. For these, payments are not deductible by the payer nor taxable income for the recipient, shifting the tax burden to the payer. For agreements on or before December 31, 2018, previous rules apply: payments are deductible by the payer and taxable income for the recipient.

Child support payments, unlike spousal support, have consistent tax treatment regardless of the agreement date. Child support is neither tax-deductible for the payer nor taxable income for the recipient. This reflects that child support is solely for the child’s direct financial benefit and does not impact either parent’s taxable income.

Asset division during divorce generally has favorable tax implications. Property transfers between spouses or former spouses incident to divorce are not considered a taxable event. No gain or loss is recognized, and the recipient spouse receives the property with the same tax basis as the transferring spouse. For example, a marital home transferred retains its original basis for future capital gains calculations when sold by the recipient.

Divorce impacts dependency exemptions and the child tax credit. The custodial parent is entitled to claim these for a qualifying child. However, the custodial parent can release their claim to the non-custodial parent by signing IRS Form 8332. This allows the non-custodial parent to claim the exemption and credit.