What can a divorce do to your retirement income? In a very short period of time, your income can move from a shared household to an individual one, and no longer be part of an employee benefit plan. You now must operate as your own source of retirement income.
What comes next is understanding your source(s) of retirement income. Will retirement plans while married be divided? What about the expenses that you must incur as a single person? Do you need to rebuild your retirement plan?
How Divorce Changes Your Retirement Income Picture
What was once devoted to a two-person household as a retirement plan must now be relegated to serving two separate households. The same goes for expenses.
Should you be in retirement or near retirement, you obviously have less time to make the necessary changes to your retirement income plan, which includes assets, expenses, and any plans that you had before the divorce.
First things first, you need to come up with a very clear picture of your income, expenses, assets, debts, and any other issues that pertain to your new situation.
Where You Are in the Divorce Process
Should you be in the negotiating process of your divorce, you need to understand the following: asset values, what rights you have to income in the future, and the tax consequences of the divorce. Don’t make any decisions until you have a clear understanding of these issues.
Before committing to the final divorce decree, carefully review the document for its ability to support your future income needs.
If you are already divorced, you need to revisit and rebuild your retirement plan with updated numbers for investment accounts, income, expenses, and a new retirement timeline.
New Household Spending
Once divorced, your financial situation can change rather dramatically. Costs for housing, food, taxes, healthcare, transportation, travel, and any family support can increase substantially.
When contemplating your new retirement income target, it needs to be based on a single person’s spending. Do not take what was once in place and simply divide it by two. You might be harming yourself if you do that.
Reliable Income Sources
Reliable income sources include Social Security, pensions, annuity income, employment income, rental income, settlement payments, and more.
Each source of income mentioned above needs to be examined for the amount, tax treatment, timing, availability, and whether it continues after the divorce.
Just because your income was sufficient as a couple does not mean that one-half of that amount will be sufficient for a single person.
Retirement Timing
Divorce can have a major impact on the following financial issues: when you retire, if you’re not working, when you return to work, and, if you’re retired, whether you adjust your retirement spending.
Should you delay your retirement plans as a result of a divorce? Doing so brings these benefits: improved Social Security benefits, higher savings, and a better overall cash flow situation.
Review How Retirement Assets and Benefits Are Divided
After a divorce, the retirement income scenario depends upon how retirement accounts, pensions, and any other benefit programs are divided. Are you aware of this?
Before executing a final divorce, it is imperative that you cover the following; account titling, beneficiary updates, and the plan administrator requirements that are handling the retirement account(s) at issue. Know your rights before committing your signature.
401(k)s, 403(b)s, and Pensions
Understand that certain employer-sponsored retirement plans and certain pension plans may require what is called a Qualified Domestic Relations Order (QDRO) before such benefits can be divided between the parties.
If you are entitled to a pension benefit, it should be reviewed for payment options, survivor benefits, any cost-of-living benefits, start dates, and any other important items.
Pensions need to be looked at differently than investment account,s as pensions typically offer less flexibility in their payout.
IRAs and Taxable Accounts
Investigate how IRAs, Roth IRAs, brokerage accounts, savings, and other investment accounts may differ on the issues of taxes, liquidity, and any other critical items.
Different accounts have different qualities to them and therefore cannot be intermingled. You cannot combine accounts at will. Know the rules before combining one account into another.
As the spouse who receives the assets from an investment account, it is critical that you understand the issue of “cost basis”, your future tax exposure, the withdrawal rules pertinent to your accounts, and how each account should fit into your overall retirement income plan.
Social Security After Divorce
Spousal benefits for Social Security may be available if the marriage lasted at least 10 years and the couple is currently unmarried. You must be at least age 62 in order to apply and be unmarried. You may be eligible for 50% of your ex’s benefits. Other rules do apply.
For a significant number of women, Social Security claiming should be carefully reviewed as a source of retirement income, as they usually have earned less during their marriage.
Before making a claiming decision, it is advised to compare the differences between divorced spouse benefits, survivor benefits, and one’s personal retirement benefits so that an informed decision can be made to provide you with the greatest amount of money.
Rebuild the Tax, Healthcare, and Cash-Flow Plan
A divorce can have a significant impact on your tax filing status, taxable income, healthcare coverage, insurance costs, and the amount of money that will be needed for your near-term needs.
The transition from married to single can bring significant changes to your income tax situation and healthcare premiums. Have you determined what the difference will be?
While in the middle of a divorce, it is prudent to avoid making any major financial decisions. Emotions are running high, and making prudent financial decisions at this time is difficult. Consulting with a trusted friend or relative is a wise decision.
Tax Filing and Support Payments
After a divorce, your tax filing status will change, as will items such as deductions, withholding, estimated tax payments, and investment income that you may receive. Consulting with a qualified tax professional is a prudent tack to take.
Another item to discuss with an accountant is the tax treatment of any alimony payments you may receive.
Finally, the issues of support payments, settlement payments, and any property transfers need to be reviewed by an accountant to eliminate any unexpected problems with your tax return.
Healthcare Coverage
Divorce generally ends a spouse’s eligibility to stay as a dependent on an ex-partner’s employer-sponsored health plan.
Should a divorce occur prior to Medicare coverage, substitute coverage will be needed by the divorcee until they are eligible for Medicare. Shopping the market for appropriate coverage for the lapse in healthcare prior to the divorce would be wise.
Healthcare premiums, deductibles, provider access, and out-of-pocket costs for the divorcee will have to be calculated and worked into the newly revised retirement income plan.
Cash Reserves and Short-Term Stability
After the divorce, your cash reserve takes on even more importance as your budget will most likely increase. Housing, taxes, moving costs, food, and legal costs will consume a larger part of your budget. Having available cash to handle these costs will be vital.
Having ample cash on hand will help avoid tapping into retirement accounts prematurely and having to sell investments at the wrong time. Cash is king!
Typically, the first year after a divorce and until a revised budget becomes predictable, having ample cash on hand will help relieve anxiety.
Create a New Investment and Withdrawal Strategy
Now that your life has changed rather dramatically, your investment scenario as well as your new needs for cash should be redrawn to take into consideration your risk tolerance, tax scenario, and retirement timeline.
With a divorce comes the realization that what once worked as a married couple may not work in the future. Your allocation of assets most likely will have changed, and your sources of income have changed as you are now a one-person income and retirement source.
As a divorcee, you need a new retirement income plan that coordinates your investments with needed withdrawals, income taxes, Social Security, pensions, cash reserves, and healthcare costs. In other words, start from scratch, either by doing it yourself or employing a qualified retirement plan specialist.
Portfolio Allocation
Proper allocation of your assets should take the following into consideration: your personal risk tolerance, diversification of investments, an ample amount of cash for immediate income needs, and longer-term income needs.
Now that you are single, the allocation of your assets will most likely need to be reviewed.
Retirement Solutions uses a method of asset allocation that has been in use for 50 years. It is referred to as the 3 Bucket Methodology. Your assets are divided based on when the money will be needed. Short-term needs for cash (Bucket #1) are used to fund your need for income over the next 1-2 years. Bucket #2 contains bonds and bond funds for money that will be needed in years 2-6. Finally, Bucket #3 contains stock funds for which money will be needed beyond year 6.
Withdrawal Planning
How you tap into your accounts should be determined in part by the taxes that must be paid when accessing such accounts. Consulting with your accountant will pay dividends when deciding which account(s) will be drawn from first, with the goal of keeping the amount going to taxes to a minimum.
Knowing how much you have as your retirement fund and how much you can withdraw safely without drawing too much is critical to the success of your retirement plan. In this instance, success is based upon never running out of money before you run out of time.
Housing and Debt Decisions
As a result of your divorce, will you keep the home, sell the home, refinance the home, downsize to something smaller, or move out of the area? Any of these events will alter your retirement income needs and should be addressed prior to making any decisions.
Also consider the following after a divorce: mortgage payment, property taxes, insurance, maintenance, and any debt obligations. How will these issues affect your retirement income plan?
Update the Plan After the Divorce Is Final
It is very likely that after the divorce is finalized, your existing retirement plan will need to be revisited and reworked. So many factors will have changed that a review will be in order.
After the divorc,e topics such as: beneficiary designations, estate documents, insurance coverages, tax withholding, account titling, and retirement plan projections will need to be reviewed. Each of these items will most likely have been altered in some manner after the divorce.
Beneficiaries and Estate Documents
After the divorce, beneficiary designations on retirement accounts, life insurance beneficiaries, annuity beneficiaries and investment accounts should all be reviewed and, when necessary, updated to reflect the changes that have occurred since the divorce.
In addition, legal paperwork such as: wills, trusts, powers of attorney, healthcare directives, and executor choices will most likely need updating.
Insurance and Risk Protection
Your divorce will impact how insurance protection is structured. You will need to review any life insurance policies for beneficiary changes, disability insurance coverage, as well as long-term care insurance.
After a divorce, insurance needs may change due to support obligations, dependent children, outstanding debt, and the possible need for income replacement due to disability.
Before making any blanket changes to any insurance policies, review what you currently have and how it fits into your new financial situation.
First-Year Review
The first year after the divorce will give you a better idea of where you stand financially. It is prudent to review your financial plan after the dust settles and you have a clearer idea of your income and expenses.
Retirement projections after the first year of divorce should be updated to reflect the new situation that you are now experiencing. Most likely, much has changed after the divorce.
Ongoing reviews of your new situation can instill confidence after a financially disruptive transition has occurred. As each year passes, you should get a better idea of where you are financially and begin to gain confidence in your ability to move forward financially.
Divorce and Retirement Income FAQs
1. How does divorce affect retirement income?
Divorce significantly reduces individual retirement income by splitting accumulated savings, dividing pensions, and doubling individual living costs.
2. What happens to 401(k)s, IRAs, and pensions in divorce?
Retirement assets earned during a marriage are generally considered marital property and are split between spouses. Contributions made before the wedding usually remain separate property. Employer plans and pensions require a special legal order to divide, while IRAs transfer directly through the divorce decree, allowing both to avoid early withdrawal taxes and penalties.
3. Can I claim Social Security based on an ex-spouse’s record?
Yes, you can claim Social Security retirement or survivor benefits based on an ex-spouse’s work record. To qualify, your marriage must have lasted at least 10 years, you must be at least 62 years old (or age 60 for survivor benefits), and you must currently be unmarried.
4. How should I rebuild my retirement budget after a divorce?
To rebuild your retirement budget after a divorce, start by conducting a full financial inventory of your new single income, updated living expenses, and divided assets. Recalibrate your savings targets, maximize individual contribution limits, and adjust your retirement timeline to reflect solo financial responsibilities.
5. Should I keep the house after divorce if I am close to retirement?
Keeping the house close to retirement often strains cash flow and depletes liquid assets. Trading away retirement funds like a 401(k) or pension share to buy out an ex-spouse can jeopardize your future financial security. However, keeping the home may work if you have low housing costs and a stable post-retirement income.
6. What financial documents should I update after a divorce?
After a divorce, you need to update bank accounts, credit cards, retirement plans, insurance policies, and estate planning documents. You should also change vehicle titles, deeds to real estate, and your tax withholding status with your employer to separate your finances completely.
Empowering Women After Divorce
Going through and coming out of a divorce can be a very emotionally and financially devastating time of your life. It is a time for self-reflection and a time to arm yourself with answers to your many questions.
For over 40 years, Retirement Solutions has been working with divorcees as they move through this challenging period of their lives. We believe that the most appropriate path for a divorcee is to take the time to reflect on one’s life, take a deep breath, and when appropriate, begin the next chapter in her life. It is most important not to make any major, serious financial decisions without the proper information.
We believe that empowering women through education is the best route to take for someone going through or just finishing a divorce. This is why we offer a no-obligation, no-cost 15-minute consultation to anyone seeking the light at the end of the tunnel. If you are interested, simply click the link in the upper right corner of the website, “Let’s Discuss Your Financial Future”. You talk, we listen.