Managing the finances after a divorce can be challenging. Here's some advice.
MONEY IS THE leading cause of divorce in the U.S. -- and financial problems continue to hound many people long after the legal ties have been severed.
Newly single folks face a difficult task in rebuilding their financial lives. Many have limited assets and severely reduced incomes that must be stretched over expenses that once were shared. Some might even face a pile of debt incurred during the divorce itself.
Needless to say, the road from divorce to financial independence can be long, and many individuals might be best off seeking the advice of a financial planner. In the meantime, here's an overview of the steps the recently divorced should take to get themselves on firm financial footing.
1. Avoid Credit Damage
During a divorce, spouses often fail to pay bills -- be it out of spite or because they feel they are not responsible for them. That often damages the credit reports of both parties. "The credit history often goes down the drain during the divorce," says Ginita Wall, a CPA and founder of the Women's Institute for Financial Education (www.wife.org).
The best strategy is to prevent such situations from happening in the first place, says credit expert Gerri Detweiler, author of "The Ultimate Credit Handbook." You should monitor all joint accounts during the divorce and, even if you believe certain bills aren't your responsibility, make the payment if your ex doesn't.
If you already have late payments on record, consider including a note in your credit report that explains why the negative information is there. (The three credit bureaus -- TransUnion, Experian and Equifax -- allow consumers to place 100-word notes at the end of their reports.)
Once your divorce is finalized and your finances are back on track, you might also want to call your creditors to see if they will agree to "re-age" your accounts. This maneuver, known as a "goodwill adjustment," means creditors list all accounts as current, essentially erasing the late payments from your file. For more on that, read our story.
2. Separate Your Credit Records
Once the divorce is final, don't assume you're off the hook regarding debts that now officially belong to your ex-spouse under the divorce decree. The truth is that as long as the accounts remain open and in both names, both spouses are responsible -- at least as far as the lenders are concerned. Yes, you could take your ex to family court if he or she fails to pay the bills, says Wife.org's Wall. But that doesn't solve the more immediate problem of late payments or prevent the possibility that an account with your name on it will be sent to a collection agency.
"The divorce decree is an agreement between the spouses on how the bills will be handled," says Detweiler. "It doesn't erase the original contract with the creditor, which says that both of you are going to be responsible for the bill."
That's why the first thing you should do once the divorce decree is signed is close all joint accounts and transfer the balances to accounts that belong to each spouse separately, advises Detweiler. The same strategy applies to mortgages. Some lenders might agree to take the ex-spouse's name off the loan after they see proof that the house has been claimed in a divorce. Others require that whoever gets the house refinance the loan in his or her own name, says Wall.
If you neglect these steps and the ex-spouse either fails to make a payment on a joint account or -- worst-case scenario -- declares bankruptcy, the negative information will appear on both of your credit reports, Detweiler explains.
Wall has seen a client get stuck with debts assigned to her ex in the divorce settlement. "His next stop after family court was bankruptcy court," says Wall. "He was absolved of the debts but her name was still on the cards and (the creditors) started coming after her." The only way for her client to get out of this situation was settle with the creditors to pay off part of the debts, even though she wasn't responsible.
3. Tweak Retirement Savings, Investments
Faced with the financial responsibilities of being single again, the many recently divorced neglect their retirement savings. Big mistake. Instead, they should reorganize their financial priorities to find a way to continue saving for retirement, says Wife.org's Wall.
It's also likely that a divorce leaves a person with investments that don't fit his or her goals, says Wall. One of her clients, for example, ended up with a hearty helping of Treasury bills that her ex-husband had bought. That was way too conservative for her client, Wall explains. (Our Asset Allocation System can help you determine the right mix for you.)
People should also keep in mind that they might be able to collect Social Security based on their ex-spouse's entire earnings history -- even earnings racked up after the divorce. This is known as "derivative benefits," according to Wall. It's particularly attractive for stay-at-home parents who have had little earned income of their own. There are, however, certain restrictions: The marriage must have lasted at least 10 years, and a person can't be remarried at the time he or she starts collecting benefits.
Derivative benefits equal half of the ex-spouse's own benefit. (In other words, if your ex-spouse were entitled to $1,000 per month, you could get $500.) Individuals need to choose between collecting their own Social Security or the derivative benefit -- whichever is more attractive. Details are available at the Social Security Administration's Web site.
4. Update Your Insurance Policies
Those who've been included on their ex-spouse's health coverage at work may be able to keep their coverage for three more years, thanks to a federal law known as COBRA. This, however, is an expensive option: You have to pay for the full cost of coverage and often as much as 102% of the employer's costs, Wall explains. It may be cheaper to get coverage on your own, especially if you have an employer-sponsored plan. Otherwise, consider buying private health insurance.
"Use COBRA only as a stepping stone before you get your own plan or if you can't qualify for insurance otherwise," says Wall.
If you're getting child support or alimony, it's important to have a life-insurance policy in your ex-spouse's name, with you as a beneficiary. "If he (dies), his new wife won't send you a support check," Wall says. In fact, many courts require that the spouse paying child support maintain a life-insurance policy in your name.
Also, make sure you update your own life-insurance policy. You should change the beneficiary and the amount of coverage, if necessary. Our calculator will help you determine how much insurance you need.
Auto Insurance and Property Insurance
Assuming you get to keep the car or the house, the insurance policies covering these items also need to be transferred to your name. Otherwise, the insurance company will write checks payable to both you and your spouse when a claim is filed. Talk to your insurance company about the necessary changes. Visit our Insurance department for more advice.
5. Learn to Live on a New Budget
It may sound like hackneyed advice, but the truth is that most people -- even those who are left with adequate resources after a divorce -- probably need to adjust their budgets a bit to reflect their new lifestyle. "(Divorced individuals) need to be conscious about spending and start rebuilding their asset base," says Cicily Carson Maton, a CFP at Aequus Wealth Management Resources in Chicago, whose clients are mostly wealthy individuals. She recommends that her clients do a recap of their spending for the last couple of years and look for ways to cut expenses even before the divorce is over. "If fixed expenses are too great a percentage of their anticipated income, they should consider downsizing and moving to a different location that may be less expensive."
Also, although it might sound impossible for someone on a limited budget, it's critical for the newly divorced to establish an emergency fund, advises Kelly Rote, a spokeswoman for Money Management International, a credit-counseling agency. Rote recommends stashing away at least three months' worth of living expenses in a cash vehicle like a money-market account. If you have a house, consider opening a home-equity line of credit, or HELOC, which is basically a credit line against the equity of your home that you can tap in a financial emergency. (For more on that, read our story).
6. Enjoy the Tax Breaks
Now that you're divorced, you might be eligible for certain tax breaks that weren't available to you when your family income was higher. For more on that, read our story "Tax Credits for All." Also, if you have custody of your child or children, you will qualify for additional tax-exemptions.