Spring 2017: Financial Considerations for Family Law Attorneys Dividing Assets During a Divorce

by Kate Austin and Sarah Wheeler, Financial Advisors at Wells Fargo Advisors

This article will serve as an overview of the types of assets and liabilities clients may have and their differences. The equitable division of these assets is extremely important. We provide a step by step guide to understanding what types of investment accounts/assets clients may have and strategies on how to divide the assets at the security level. This can help lower trading and commission costs. Through our case study, we will delve into understanding a client’s short term and long term goals and analyze different types of investment accounts.

Case Study of Jane and John Smith

The parties were married 20 years ago. Jane, our client, was a teacher who quit her job at 35 to take care of her children; she has been out of the workforce for 15 years. Her husband works at GE in management and makes $350,000 per year. There are two children ages 17 and 12. The eldest is leaving for college soon at a private university and the youngest is in a private day school, Jane will be responsible for 1/3 the education costs. Child Support ends at 18. They have a mortgage balance of $600,000 with a rate of 4%. Jane will get alimony payments until age 66, with a monthly alimony and child support payment of $7,432. No pre-nuptial agreement was signed.

Total Value of Pre-Divorce Marital Estate: $4,000,000

This case study is hypothetical. It is not intended to represent any actual person(s) or investments and is for informational purposes only.

Investment and insurance products:

NOT FDIC-Insured - NO Bank Guarantee - MAY Lose Value

  1. Create a Balance Sheet of Jane’s Divorce Settlement

  1. Understand Short Term and Long Term Goals of the Client
  2. What the client wants and what is in the best interests of the client is not always the same. Often the most reasoned logic is trumped by an emotional attachment. Having an idea of the client’s short term and long term goals does not only get the client thinking about what they want and need after the divorce but also can give you an idea of how to split up assets at the security and account level. This will reduce trading costs and may lessen the tax burden for the client when they include a financial advisor in their holistic plan after a divorce.

    Jane Case Study:

    • Jane does not intend to re-enter the workforce
    • She wants to keep the marital home
    • She needs enough money to live comfortably in retirement 
  3. Understand at the Account and Security Level
  4. Dividing the accounts at the security level as part of the divorce settlement is extremely important. This is a brief overview on what types of securities are best for each specific account, and what a client should look for in a settlement.

    Basic Overview of Accounts and Analysis

    Traditional IRA – Pre-tax dollars fund the account, the account grows tax deferred and taxes are paid on the distributions. If the account is liquidated before age 59½ there is a 10% penalty (with some exceptions1). A Required Minimum Distribution (RMD) is a minimum amount that the owner of the account must withdraw each year set by the IRS starting the year after the client turns 70 ½.

    Jane Case Study: As part of Jane’s settlement she should try to obtain more aggressive investments such as equity securities and structured products from her husbands’ Traditional IRA account. These will be transferred (not distributed) into her Traditional IRA account as part of her settlement. Jane expects to be in a lower tax bracket in retirement (i.e. lower income requirements and no alimony), so she will only pay regular income taxes on distributions when she takes them at retirement age. Investments within an IRA are tax-deferred, so long-term capital gains tax-rates will not apply. Aggressive investments with larger expected long-term capital gains could be more tax-efficient in this respect. These securities are also part of a divorce settlement, so Jane can move these securities into her own Traditional IRA without taking a distribution and getting penalized.

    Roth IRA– Post tax dollars fund the account and if securities (stocks or bonds) are held for more than 5 years, no tax is due upon qualified distribution. Because taxes have already been paid, and capital gains taxes will not apply to investment gains in the account, the Roth account should be the most aggressive of all the accounts. Depending on the client’s risk tolerance, age and time to retirement we would generally want the client to be awarded as many high growth equities as possible for this account as part of her settlement.

    Jane Case Study: Jane is 50 years old and assuming a retirement age of 65, she has 15 years to retirement. This time horizon allows Jane to take a bit more risk, if she is comfortable. The Roth should be a part of a diversified plan for Jane. Depending on her risk tolerance, we would like to see Jane awarded high growth equities as part of her settlement from the Roth. This is not a distribution, because Jane is not liquidating the position, merely rolling it over into a Roth in her name.

    These securities do not incur a 10 % penalty if they are held for 5 years and if Jane is over 59 ½. There is no Required Minimum Distribution in this account. The Roth gives Jane a bit more freedom of when and how much to distribute from the account if she needs. However, a client should almost never prematurely liquidate retirement assets before they need them in retirement.

    Other (Taxable) Investment Accounts – Single securities are bought and sold in a taxable account. The account is funded with post-tax dollars and any price appreciation is taxed upon sale.

    Jane Case Study: Ideally, Jane should be awarded tax advantaged securities from this account, such as municipal bonds, because she will receive the greatest tax benefit and diversity in her accounts.

    401(k)2 - An employer sponsored retirement account, where Jane’s husband puts a portion of his pretax income that the employer will match in some capacity.

    Jane Case Study: If Jane receives a piece of her husband’s 401k she can roll it over into an IRA, take it out as a lump sum cash payment or keep it in the existing plan. This can only be done if the divorce decree orders the division of the 401(k). Jane needs to understand that if she rolls it over into an IRA or if she takes it out as a cash payment she will not pay the 10% penalty tax if the 401(k) plan administrator approves the Qualified Domestic Relations Order (QDRO)3. Depending on the specific investment-related advantages and disadvantages of each option, we would work with Jane to determine which option is best for her.

    If it is rolled into a Roth IRA taxes will need to be paid in that taxable year, when Jane may not have as much cash on hand or when Jane may be included in her husband’s higher tax bracket. The QDRO must be created by the party attorney as soon as possible after the divorce decree because the funds in the 401(k) can be vulnerable until this change is finalized.

    Life Insurance – Whole Life insurance and Universal Life insurance that accumulate cash value should be viewed as an asset. This is because the cash value can be lent against or it can be cashed out. Term Life insurance does not accumulate a cash value.

    529 Plans – Tax advantaged plans mean that any earnings that accumulate in the account are not taxable; however the distributions in a 529 plan can only be used for higher education expenses.

    Jane Case Study: Jane is responsible for a third of the children’s college expenses. Thus, the 529 Plan is an important account for Jane, if she uses her brokerage account to pay for college she is looking at a high tax burden. Since her children are near college age she will need to periodically pull cash out from the account. We would want this account to be fairly balanced with equities and bonds in an effort to maintain growth and stability.

    Cost Basis – This is the original value of the security. The difference between the purchase price and the sale price is known as a capital gain (loss) and is generally subject to capital gain tax rates. The cost basis does not reset when going through a divorce – only when the securities are inherited from someone who is deceased. So the original cost basis that the securities were purchased at is the cost basis for the account.

    Jane Case Study: John has Apple stock in his portfolio that he bought at $100 and it now trades at a market value of $150. If John sells the stock now he will be looking at a $50 capital gain per share. If at the time of the divorce the stock has appreciated to $200 and Jane sells it after her divorce settles she would have a $100 capital gain per share. Since John is still alive and the shares were transferred, the original cost basis of $100 stands. So Jane is looking at a significantly higher tax burden if the securities she receives as her settlement are not securities she would like to keep.

  5. Conclusion
  6. Understanding a client’s short term and long term goals with a holistic investment plan are essential in dividing their marital assets and allowing them to live comfortably.

    Since Jane wants to keep the marital home, we would want her to understand that keeping the marital home as part of her settlement will require further cash injections (i.e. upkeep, taxes etc.) Furthermore, if Jane will not reenter the workforce she will likely need more retirement assets than investment assets. Child support and alimony are generally only about one third of her pre-divorce incomes, which may not be enough to support her goals.

    We are able to perform an in-depth analysis for you and your individual clients in order to explore the right solutions for their specific needs and aspirations.

1 Large hospital bills, health insurance, higher education, first time home purchase, and payments to the IRS
2 When considering rolling over assets from an employer plan to an IRA, factors that should be considered and compared between the employer plan and the IRA include fees & expenses, services offered, investment options, treatment of employer stock, when required minimum distributions begin, and protection of assets from creditors & bankruptcy. Investing and maintain assets in an IRA will generally involve higher costs than those associated with employer-sponsored retirement plans. You should consult with the plan administrator and a professional tax advisor before making any decisions regarding your retirement assets.
3 The party attorney must submit a QDRO to the 401(k) plan administrator in order to divide the 401(k).

Wells Fargo Advisors is not a legal or tax advisor.

Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company.

About The Grinnell Souza Group of Wells Fargo Advisors

The Grinnell Souza Group of Wells Fargo Advisors is a diverse team of seasoned professionals with a Family Office Approach. Their distinctive perspective for nonprofit management is rooted in a collaborative philosophy. They offer tailored advice and services for UHNW and HNW families. They specifically focus on aiding women during transitional periods in their lives. Their practice spans both the East and West coasts.

Kate Austin guides individuals and families to invest their money wisely and plan holistically for life’s unexpected turns. She focuses on understanding a client’s needs and goals in order to tailor their investment strategy. She also hosts financial education events for women called “Smart Women Plan Ahead” both on the east and west coast.

Kate earned a Bachelor in Fine Arts in Dance Performance with a minor in French from Butler University where she was a Dean’s List student. She was a professional ballet dancer at the Richmond Ballet in Virginia and a Brand Ambassador at Saks Fifth Avenue. She later pursued her passion for finance, earning her MBA and MS in Finance at Boston College’s Carroll School of Management. Kate was born in San Clemente, California and currently lives in Beacon Hill in Boston.

Sarah Wheeler helps families and individuals align their investment strategy with their personal values and evolving lives. Sarah works comprehensively with clients, from investment strategy to day to day needs. With particular expertise in planning and guidance for women, she has partnered with Kate in their important work in this area.

Sarah received her bachelor’s degree from Georgetown University, where she graduated with a Varsity Letter in field hockey and also as a dean’s list student. She worked at General Dynamics in their Contracts Division for Homeland Security, as well as Macy’s Executive Development Program at their New York corporate headquarters. She earned her MBA and MS in Finance from Boston College’s Carroll School of Management. Born and raised in Weston, Massachusetts, she now lives in the Back Bay of Boston, MA.