We all know that things don’t end because they are good. If you find yourself separating from your spouse, here are some things you will want to make sure that you consider.
Please be sure to consult your attorney and / or CPA for the ramifications of these decisions.
How much house can you afford?
• The rule of thumb is that you shouldn’t spend more than 25% of your gross income on housing costs. This includes the mortgage as well as the electric bill. People often end up “house poor” following a separation. Using this rule of thumb will let you know how much you can afford.
• Also, pay attention to your total debt payments each month. Ideally, they shouldn’t be more than 40% of your paycheck.
Which assets should you keep?
• Many people want to keep the house when they separate. The problem is that most of the time, the house is not an income producing asset. This can be problematic with relationship to your total financial picture.
• Another mistake that I’ve seen made is that the cost basis of an investment is not taken into consideration. If you have two investments that are both worth $100,000, but the cost basis on one is $20,000 and the cost basis on the other is $90,000, the tax treatment upon sale would be quite different. If we assume a 20% tax on gains, the first investment have taxes due of $16,000 on sale [($100,000 – $20,000) x .2]. The second would have only $2,000 in taxes due at the time of sale [($100,000 – $90,000) x .2]. Tax consequences are important and add up over time.
• What about the retirement plans – these can be great assets to keep, just realize that you will potentially need to pay ordinary income taxes on these assets when you withdrawal the funds. There can be some tricky timing with these assets and penalties that are paid for pre- 59.5 withdrawals, so be sure to work with your advisor, CPA and attorney on making sure that these assets are structured properly in the legal documents and execution of them.
Do you need to make sure that your soon to be former spouse maintains insurance?
• Consider disability coverage if they are paying you alimony or child support. If they are unable to work, you need to make sure that you will still be paid. Disability coverage will insure that income source even if they are disabled.
• Don’t forget about life insurance. This again covers income payments that you could be due, and it also covers other areas that may be part of your separation agreement such as the cost of college for a child.
Do a projection of what the total settlement looks like for you financially.
• How does this impact you today? Will you be able to comfortably get by?
• What does your situation look like ten years down the road if you agree to this settlement?
Proper planning when separating can make a huge difference in your future. Make sure that you are covering all areas so that you don’t have any surprises down the road.