Avoid These Tax Tragedies

All assets are not created equal. This is because of the tax consequences associated with different types of investments and the types of accounts that hold the investments.

For example, in divorce, you wouldn’t want to offset home equity with a retirement account dollar for dollar. There are a couple reasons for this. Number one, you want to make sure that any home equity is net of selling costs and any capital gains tax, and number two, because many retirement accounts like a Traditional IRA or 401K will incur ordinary income tax upon distribution in the future. Make sure you and your attorney are comparing assets “apples to apples” before beginning to negotiate.

Here are some basic tax implications that you should be aware of:

  1. Traditional (pre-tax) retirement accounts like Traditional IRAs and 401Ks will be subject to ordinary income tax upon distribution (and you want to wait until after age 59 ½ to avoid penalty). This means the funds in the account should not be traded for cash of the same value – the retirement funds are worth less because of the tax liability associated with them.
  • Brokerage accounts with the same fair market value today may have very different after-tax values. Said differently, two investment accounts valued at $100,000 should not be considered equitable until the cost basis of each account is determined. The difference between the cost basis of the investments in the account (how much was originally paid to purchase the securities) and how much they are worth now will be subject to capital gains or loss upon sale.
  • If you are splitting securities within the investment accounts, make sure you know the cost basis of each security. Just because you own 10 shares of Apple, you can’t just say that you will each receive 5 shares. You must determine the after-tax value of each share in order to make sure you are dividing assets equitably. This means that one spouse may need to receive less shares in order for the total after-tax value to be split equally.

It is extremely important to understand the tax implications of the different types of accounts you and your spouse own and are trying to divide. If you don’t, THEN ASK QUESTIONS!

Unfortunately, it is very common for a Marital Settlement Agreement to state that each spouse is entitled to 50% of the various accounts, but it will not state how that 50% is going to be calculated, what tax rate to use, etc. These are very important details that need to be included in the MSA language so that when accounts are being divided it is crystal clear as to how the divisions should be made and in what timeframe. Don’t assume that someone else understands better than you do or that these things will be figured out later. They won’t.

Hire a CDFA™ Professional to review your accounts and MSA language BEFORE you sign!

Schedule your free Clarity Session

Only ten 30-minute sessions available each month, reach out today to get scheduled

In this session we will:

  • Explore the various divorce options and understand which solution is right for you and why
  • Review your main areas of financial concern and consider the best ways to address them
  • Explore creative settlement ideas geared toward your values and goals for the future
  • Get clear on the next steps to begin moving forward
  • Connect you with the qualified resources that are best suited for your divorce process

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