What you need to know about splitting assets in divorce

Understanding different types of assets, and the costs and taxes associated with each, can help you make informed decisions in a divorce.

A divorce can be painful and messy. The worst part is often dividing everything you've worked so hard to build together.

To help ensure that you come to an agreement that is fair and equitable to both of you, it's important to know what you have now and understand how your divorce agreement could potentially impact your net worth, income, and lifestyle.

Here are the top things to know about 5 broad categories of assets you may own, as well as some considerations when planning for the future for your children. Consulting with a Fidelity financial professional is also a good idea.

Keep the house or sell it?

When it comes to divorce, the family home is a particularly emotional matter. But it's important to look past its sentimental value and focus on the financial aspects to make the best decision for your future. Here are the key financial options.

Sell the house. Ask yourself: What is the value of your house after paying off the mortgage, brokers' fees, and taxes? It's important to get a fair and accurate appraisal in order to divide the property equitably. In general, you can exclude profits from the sale of a primary residence on your taxes, up to $250,000 for single filers and $500,000 for joint tax filers. As long as you have at least 2 years of ownership and 2 years of use during the 5 years before you sell the home, the ownership and use can occur at different times. However, if for example you owned and lived in the home for only one-half of the required 2 years, then this exclusion is reduced. Other things to think about: How long will it take to sell the home? And what are your alternative living options short and long term?

Keep the house. Ask yourself: Can you afford the house considering the mortgage, real estate taxes, homeowners insurance, and upkeep? And how will you handle the mortgage? You may be able to assume the existing mortgage—essentially taking the ex-spouse off the existing loan—if your lender allows it. Or you may need to refinance. But can you qualify for a refinanced mortgage using only your post-divorce financial profile?

To help make a decision that makes financial sense, build a new budget showing your post-divorce cash flow and analyze the costs of your current home compared to living someplace else.

Splitting retirement accounts

To understand the value of a retirement account, you need to know how withdrawals will be taxed. In general, there are 2 main types of retirement accounts: traditional and Roth.

In a traditional account, contributions are made before taxes—or you get a tax deduction for the amount contributed if it has already been taxed. Contributions to a Roth account are made after taxes are paid but the benefit is that withdrawals of earnings and contributions in retirement are not taxed.1

Bottom line: $100,000 currently in a Roth is worth more than $100,000 currently in a traditional retirement account simply because of the different tax treatments in each type of account.

To split a workplace retirement plan like a 401(k), 403(b), or a pension plan, a court-issued document called a qualified domestic relations order (QDRO) is required.

To split an IRA or health savings account (HSA), financial institutions generally require the parties to submit a "transfer incident to divorce" form as well as a copy of the divorce decree. Fidelity requires a copy of the divorce decree or legal separation order signed by a judge along with the form.

The form you need: Change of account registration

Be sure to update your beneficiary information as soon as possible following the divorce. The payment of accounts after your death is generally governed by the most recent beneficiary designation on file so it's vital to keep them up to date. Your estate planning documents such as a will or trust generally would not govern unless you specifically named the trust as the beneficiary. You should consult an attorney if you have any specific questions about your situation.

Find out: How to update your beneficiaries

Taxable investment accounts

When it comes to taxable investments, it's not about the value you see on your statement, but what you get to keep after taxes.

In general, when dividing investments in a divorce, couples may have options: One option would be to sell investments and divvy up the proceeds. This can have tax consequences. Alternatively, you can generally split the investment holdings. For instance, if 100 shares of stock are part of the marital property to be divided in half, one party gets 50 shares and the other party gets the remaining 50 shares. The IRS allows divorcing spouses to each keep the same cost basis and holding period for an investment they already own. Cost basis is the price at which the investment was originally purchased. Holding period is important because profits from the sale of investments owned for a year or less are taxed at your ordinary income tax rate, while investments held for more than a year are taxed at lower long-term capital gains rates.

Assuming your investment has appreciated, you will end up with less than the sale price—because you have to pay taxes on any gains over the cost basis. Exactly how much will depend on your tax rate, holding period, and cost basis, which can vary for a single investment if you bought shares over time. So, if you're dividing investments equally, it's important that the cost basis is divided equally as well—your financial institution or Fidelity representative should be able to help with that.

Of course, other important things to think about with regard to investments are the future prospects for growth or income, your own tolerance for investment risk, your financial needs, and your timeframe for investing.

Who gets the health insurance?

Health insurance is a valuable asset too. Generally speaking, when the policy is through an employer, the health insurance stays with the primary owner. But some states have laws that require employers with group policies to make them available to ex-spouses after a divorce. In some instances, you may have continued workplace health insurance coverage for a period of time after divorce.

If you don't have coverage of your own at work, you may be able to continue your spouse's existing coverage through the Consolidated Omnibus Budget Reconciliation Act (COBRA) provisions of your health insurance which allows you to continue your current coverage for up to 36 months. It may cost substantially more than your health insurance cost before the divorce, however. So, you may want to compare the COBRA cost with policies on your state's health insurance exchange under the Affordable Care Act.

Ensuring that children have health insurance coverage is often a part of negotiations in divorce. Employers are required to extend group health care coverage to children of workers eligible for the plan. If one parent has coverage through an employer, keeping the kids on the policy is often a solution. If there's no employer plan, making sure that kids have health insurance coverage may be part of the child support orders.

Social Security and life insurance

If your marriage lasted 10 years or more, and you have been divorced for more than 2 years, and you are unmarried, you can claim Social Security benefits on your ex-spouse's work record once you reach age 62. There are some other caveats: You can only file on your ex-spouse's work record if the benefit you would get based on your own work is less than the benefit you would receive based on your ex-spouse's work.

Your benefit as a divorced spouse is equal to half of your ex-spouse's full retirement amount, if you start receiving benefits at your full retirement age.2

If you're receiving alimony or child support after divorce, life insurance on the person making payments may help protect that income. It is possible to set up the divorce agreement so that the cost of life insurance is included in alimony or child support payments.

Disability insurance should also be a consideration. In some cases, divorcing couples may be ordered to split life insurance policies. Whole life insurance has a cash value and may also be on the table for division in a divorce.

With no support issues to consider, it is important to review your life and disability insurance, especially if you have been covered by an ex-spouse's employer plan. It may make sense to think about your specific insurance needs.

Protecting kids in divorce

Planning for the future of your children is one of the most important considerations in divorce. To minimize, and perhaps even eliminate, conflict down the line, it can be helpful to make plans for your children's possible future financial needs like tuition, braces, and summer camp.

It may also be useful to seriously consider various college scenarios—for instance, getting into a pricey and prestigious private school versus a state school. Deciding ahead of time how to handle things may smooth the way ahead.

College saving accounts, like a 529 plan account, may be considered marital property, which means that ownership of the account may be part of the negotiations. One consideration in determining which parent may be the most appropriate owner may be financial aid—even though the impact may be minimal. Because 529 college savings plan assets are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of only 5.6%.

In general, ownership of a 529 plan cannot be transferred except when it's required by court order—like a divorce decree. Fidelity requires specific documents to be completed in order to transfer ownership of a 529 plan account due to divorce:

  • An official court order with raised seal, which clearly identifies the name of the person to whom the 529 account is to be transferred
  • A letter of instruction signed by both the current and new participant
  • A new 529 account application completed by the new participant for the named beneficiary

Other financial institutions likely have different rules and procedures. So, if your 529 plan is held at another firm, take the time to investigate their requirements.

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