The unhappy truth about marriage is that about half1 of them end in divorce each year. Most people don’t consider the types of changes that can occur when the specter of divorce enters their lives or the life of an intended beneficiary. But as you might imagine, divorce makes it that much more important to have legal affairs updated and reviewed. Without strict planning, a divorce could have devastating consequences for your family.

Although emotional upheaval may seem difficult as a result of a divorce, the hard work associated with returning your life to normalcy doesn’t end with divorce. It’s important to know how divorce dramatically affects your estate plan.

AN INITIAL STEP: REVIEW BENEFICIARY DESIGNATIONS

After you divorce, it is important to update your beneficiary designations on financial instruments such as life insurance policies, stocks, bonds, and other assets. You must, however, only make changes that are allowed in your divorce decree. You may be obligated by court order to name your ex-spouse as a beneficiary for a specific amount of life insurance proceeds. In addition, your ex-spouse may be entitled to a portion of retirement benefits accrued while you were married.

Your estate planning attorney can help you determine which assets can be assigned new beneficiaries. In general, you should have all estate planning documents reviewed. In particular, you’ll have to review your fiduciary designations with the following questions in mind.

  • Who is designated as the trustee of a trust?
  • Who is the Executor / Personal Representative of a will?
  • Who is the Agent under a Property Power of Attorney, Health Care Power of Attorney, or Health Care Proxy?

Many states have statutes which preclude an ex-spouse from inheriting under a will created during marriage. Some of the statutes also apply to trusts and beneficiary designations on life insurance or retirement plans. However, the laws vary tremendously and resolution of the matter can be further complicated where a divorce occurs in one state, but the estate plan or beneficiary designation is governed by the laws of another state or the federal government.

DIVIDING ASSETS

In the long run, the assets that are awarded to you and the manner by which they were obtained can pose serious tax consequences. Let’s look at the assets most likely to cause you grief if not handled properly.

Appreciated Assets: This may include real estate, mutual funds, stocks, artwork, or collectibles. Great care should be taken as you consider who gets what, or you may be setting yourself up for a painful capital gains tax bill in the future. Typically, each spouse keeps their own personal property such as jewelry, books, and clothes.

Real Estate: The divorce language requires many decisions to be made since it dictates which spouse will own and reside on the property, pay the mortgage, taxes, insurance, utilities, and repair expenses. This language also outlines how profits from a possible sale of the property will be divided.

Your Home: For most couples, the home is the most expensive asset and is typically jointly owned. As the details of your divorce settlement are being defined, you and your spouse will probably face three options – each with its own unique tax consequences:

  • Option 1: The home is sold immediately and the proceeds are split. There would be no capital gains tax on the sale of the residence, as long as the couple lived in the home for at least two out of the five years immediately preceding the sale and the gain is no more than $500,000.
  • Option 2: The home is sold at some future date and the proceeds are split at that time. If the divorce settlement allows one spouse to remain in the home for three years or more before it is sold, adverse tax consequences could be the result. The non-resident spouse will no longer be entitled to the $250,000 exclusion from capital gains to the non-resident because the home no longer qualifies as his or her principal residence.
  • Option 3: One spouse buys out the other’s interest in the home. If the sale takes place as a part of the divorce, up to one year after the divorce decree, then any gain is not recognized. The person who receives the house would have the income tax basis of both parties in the house. However, the rules are normally different if it’s been more than a year since the divorce decree.

ADDITIONAL CONSIDERATIONS

In our next issue, we will address the other areas you will need to consider in the event of a divorce, including retirement accounts, taxes, Joint Tenancy assets, Guardianship considerations, and what estate planning strategies are best for your changing situation. If you or your child are currently facing a divorce, contact us today to schedule an Estate Plan Review meeting so that we can make sure your interests are protected.

1 https://www.apa.org/topics/divorce/ (Encyclopedia of Psychology)