WINTER 2019: Tips to Consider When Looking at Client Assets

B, Elizabeth Lavoie

As investment advisors and financial planners we often work with clients for decades. Over the course of our relationship significant life changes occur. And sometimes we work with clients who are divorcing or divorced. When clients tell us about their situation earlier in the process, we feel fortunate we have the opportunity to make some recommendations and share insight which could benefit them financially and ideally make them happier.

One technical issue we see clients dealing with due to missing provisions in their separation agreements is not being able to get funds from a 401k plan. If one spouse is awarding another spouse a percentage of a 401k plan the date of the valuation should be included (which might be a separate negotiation). In addition, loans and any gains and losses from valuation date and the actual pay date need to be addressed. For example, if a loan is taken out against a 401k after the settlement but before the QDRO is executed, the recipient might not get the amount expected and/or it could delay the distribution. Another issue is unaccounted for Irrevocable Life Insurance Trusts. If the trust doesn’t contain language that addresses the possibility of divorce, then a beneficiary or trustee would need to waive his or her rights to the trust and the trust would need to be modified or decanted into a new trust. The best practice is to consult with professionals like a financial planner with QDRO experience and an estate planning attorney in the negotiation and/or drafting stage of a settlement so clients don’t have to incur additional legal costs and headaches after the agreement is finalized and they thought everything was taken care of and provided for.

Future tax burdens should be considered when assets are being divided as well. If divorcing couples were given a better understanding of what would end up in their pockets after taxes, they might want to split assets differently or even negotiate harder on support issues. Investment-type accounts, like retirement accounts are taxable, and the basis of the holdings should be analyzed for tax liabilities and apportioned accordingly, whether that be equally or in some other manner depending upon how that (or other) assets are being divided.

How a primary or vacation residence is transferred should be considered from a tax perspective as well. It could make sense to make it a taxable event. Here are two examples of this:

Scenario 1: Tax-Free Transfer

Jill gets Jacks share of the home and it happens as a tax-free transfer. The home is valued at $1,000,000 and the basis is $600,000, which is now entirely Jill’s.

If Jill then sells the home at the current value of $1,000,000 she realizes a capital gain of $150,000 ($400,000 less the $250,000 exclusion.) If it were a secondary or vacation home, her taxable gain is $400,000.

Scenario 2: Taxable Transfer

Now let’s say Jack sells his one half share of the home to Jill. He incurs no capital gain ($500,000 less $300,000 less $250,000) or half of the value less half of the basis less the real estate exclusion.

Jill then has a basis of $800,000 (her $300,000 one half basis plus Jack’s $500,000 stepped up basis.) Now if she sells the home for $1,000,000 she doesn’t have a capital gain (1,000,000 less $800,000 less $250,000).

However, if this is a vacation home Jack will incur a $200,000 capital gain from the sale or transfer; and likewise Jill, if she sells the home for $1,000,000.

Child-related tax implications should also be considered. A child must live with a parent more than half a year to be a dependent. Although the dependent exemption was suspended under the Tax Cuts Jobs Act from 2018 – 2025, there is still a higher standard deduction when filing as head of household:

Prior 2018 Standard Deductions:

$13,000 – Married Filing Joint or Surviving Spouse
$9,550 – Head of Household
$6,500 – Married Filing Separate or Single filer

2018-2025 New Standard Deductions:

$24,000 for Married Filing Joint or Surviving Spouse
$18,000 for Head of Household
$12,000 for Married Filing Separate or any Single filer

So, when there is more than one child and the custody is essentially split, it is possible for each divorced individual to file as head of household .

Getting an accurate and fair value of a Massachusetts defined benefit plan can be tricky too. And again when these funds are withdrawn this is typically a tax liability, so consulting a tax professional with a lot of experience working with divorcees can’t hurt and is a great way to help a client understand what their net, spendable resources will be each year.

In addition to helping clients grow and protect their assets we wealth advisors help them achieve their financial goals so they feel good about where they are financially. People have a lot of hang ups and misconceptions about overseeing their finances. Without adequate knowledge, resources, and guidance people can make costly financial decisions, that can result in quantifiable setbacks to their goals. To stay or get focused and prepared, individuals going through a divorce should do a new personal budget so they know what they need for the near term. They should also consider what might be different in this new life phase such as a new job, school, or new hobbies, and should be encouraged to reevaluate their budget periodically and especially any time there is a new phase or life, and in particular when entering retirement.

These things all have financial implications so working with a planner to do a long term forecast might help clients with negotiations during the divorce process and hopefully give some peace of mind during what is a difficult and time in their lives filled with uncertainty.

Elizabeth Lavoie is employed at Lexington Wealth Management where she works closely with wealthy individuals and families, as well as institutions, to build customized and strategic solutions and manage investment assets to achieve unique and specific goals.