First Person: 3 Costly Divorce Mistakes

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Divorce is an expensive process, in terms of both money and emotions. Most people do not have an unlimited supply of either.

In my divorce practice, the best advice that I can give people is to remain focused and not create unnecessary drama. There is a non-scientific study that shows legal fees rising in direct proportion to the incidents of drama, so remain calm (easier said than done) and minimize your legal expenses. Remaining calm will help you reduce the chance of committing a serious and costly error during the divorce process and immediately following. Here are three common errors that people make during the divorce process that they could easily avoid.

Division of assets

Do not divide any retirement asset until the divorce is final and approved by the court. There have been instances where parties, in an attempt to speed the process, have transferred IRA property before the divorce. The consequences can be disastrous. The party who initiated the transfer has incurred a taxable event and if they are under 59-1/2 will have to pay a 10 percent penalty. The person who accepted the transfer may incur an excess contribution penalty of 6 percent. The remedy is simply to wait until the divorce is final before moving assets.

Front Loading Alimony

The person who pays alimony will receive a deduction on their tax return and the person who receives it must declare the payments as income. There have been instances in which a spouse has suggested that they give a large amount of alimony over the first few years and then allow it to fall off sharply.

Do not do this. It is only an attempt to disguise the transfer of property, which is not a taxable event, into a process that makes the recipient declare income. To combat this practice there is, in effect, the Alimony Recapture Rule. The rule states that if payments decrease substantially during the first three years, the amount of alimony that you deducted is subject to recapture. If the payments decline by $15,000 or more each year, or by $30,000 between years 1 and 3, each person may have to recompute their taxes and restate the amount of alimony that was deducted. It will be a lot less. As an example, if you paid out $100,000, $75,000 and $50,000 during the first three years, you would have a problem. The rule will require that you restate your tax returns and declare $37,500 as income. Of course, the recipient will have to amend their return, and will report a lower income.

No Life Insurance

Often people fail to require that the person who will be paying the alimony and or child support obtain life insurance in the appropriate amount to cover the payments. If you are expecting child support and alimony for the next 10 years and your ex dies suddenly, your entire financial situation will be in more disarray.

The simple remedy is to have the payer obtain a life insurance policy in which you are either the owner or irrevocable beneficiary. As the owner or irrevocable beneficiary, the insurance company will notify you if the premiums are not paid and you can take corrective action. The premiums paid for the life insurance policy are considered alimony. The insured will receive a tax deduction and the beneficiary will have to declare that amount as income.

Avoiding these three common errors can save you large sums of money.

More from this contributor:

Divorce American Style

How to Invest Like President Obama

Helping Couples Communicate their Financial Goals


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