Chapter 12: Special circumstances.
Because no two people are alike, it is safe to assume that no two financial planning situations are alike. We all handle our finances differently, even if we have the same job, make the same money, and have the same number of children. Financial planning is an inherently personal process and planners must make sure that they communicate this to the person or people sitting at the table. Every situation is unique.
Of course, some situations are "more" unique than others. Not every financial plan will be constructed around a husband, a wife, and two and a half children. According to the 2005-2007 U.S. Census Bureau American Community Survey (ACS), less than 50% of all American households consisted of married, oppositesex partners. That leaves a great deal of households that are not "typical." Consider the following types of atypical households:
* one person households, such as widows or divorcees;
* unmarried partner households; or
* same-sex households.
Each type of household comes with very different issues. The planner must be prepared to elicit (with a great deal of poise and tact) the information needed to complete an accurate financial picture and be able to create the necessary projections. This is often a very complicated task. Some clients will be more than willing to divulge every nugget of information about their life, financial and otherwise. Others will play it close to the vest and may not be willing to discuss matters that do not have a dollar sign attached to them.
Nothing stirs up a financially stable marriage more than divorce. It is painfully clear that two individuals in separate households cannot live as cheaply as one married couple. All too often the financial aspects of a divorce are worked out between the soon-to-be exspouses or, worse yet, themselves and their attorneys, without the assistance of a qualified financial advisor during the divorce process. Financial planners are all too often brought in only after the fact, even though they can play a valuable role in:
1. assisting the client in identifying financial goals - this focus will often lead to a less messy financial separation since at least one party loses what he or she needs financially;
2. structuring property settlements;
3. negotiating the "proper" amount of alimony or child support;
4. ensuring that the right assets are transferred in the most tax efficient manner; and
5. helping the client deal with financial burdens that he may never have handled before.
Like widows, divorcees are often on their own for the first time in their adult life. The financial pressures often seem overwhelming, especially if your client feels like their "ex" got the better end of the deal.
If a divorce is inevitable, there are certain financial actions that should be started immediately. The following should be done in consultation with an attorney if one will be retained:
* establish bank, brokerage, and other financial accounts in the client's own name;
* obtain new credit cards and establish the client's own credit rating (especially if the ex-spouse was not too good with money);
* change the beneficiary designations for retirement plans and life insurance; and
* make any necessary adjustments to estate planning documents such as wills and powers of attorney.
One of the biggest decisions that needs to be made in a divorce is what happens with the house. Obviously, one of the two spouses will be out the door. In certain cases, it may make sense for both to leave.
Although the dominant factors influencing the decision to stay in or leave the home are emotional, the financial considerations need to addressed quickly. Can the client afford to stay in the marital home? If so, for how long before a "downsizing" of the financial burdens of a house must be reduced? Planners may need to deal with feelings of entitlement or unwillingness to "tradedown." Too often after a divorce the former marital house becomes a burden instead of a home.
If not done as part of the divorce planning (before or while negotiations are underway), a new budget for the newly or soon-to-be divorced client, with a cash flow projection, should reveal whether the house is affordable or not. Be sure to consider all sources of income and expenditures and tactfully challenge the client's estimates. If this is not the first time through the budgeting process for the client, it is likely to be the first time going through a divorce.
Close attention needs to be paid to the division of retirement assets. Next to the house, retirement assets typically hold the most value, but also come with a cost--a potentially large tax cost. Even if assets are divided "equally," one spouse may end up in a much better financial situation than the other.
Example: Al and Dorothy Palmer are divorcing after 15 years of marriage. They are both 40 years old and have amassed $500,000 in a joint savings account and $500,000 in Al's IRA. They do not own any other assets, see no need to hire an attorney, and agree to divide their assets in half. For simplicity, Al suggests that Dorothy takes the savings account and he will keep the IRA. Although Al's suggestion does divide the assets in half in total, he is leaving himself without any current assets. Since he is under age 59 1/2, he is unable to tap his IRA without penalty--and he would need to pay income taxes on top of that.
Many divorces are settled with regular "periodic" payments being required from one of the former spouses to the other spouse. The structure of these payments will determine whether they are classified as "alimony" or not. Alimony is deductible by the payer and taxable to the recipient. On the other hand, property settlements and child support are not deductible by the payer and are not taxable to the recipient.
Payments will qualify as alimony only if all of the following requirements are met:
1. Payments must be made in cash.
2. Payments must be received by or on behalf of a spouse under a divorce or separation agreement.
3. The spouses must not be members of the same household at the time payments are made.
4. The parties must not identify the payments in the agreement as not being alimony for federal tax purposes.
5. Payments must terminate no later than at the death of the recipient and there must be no liability to make any payment (in cash or property) as a substitute for such payments.
6. The spouses must not file a joint return with each other. (1)
Child support is not treated like alimony for federal income tax purposes. Payments which otherwise qualify as alimony but are reduced upon the happening of an event involving a child will not be treated as alimony. (2)
In order to allow for the transfer of one spouse's defined contribution retirement plan (e.g., 401(k)) to the other spouse in a divorce, a court may issue a "qualified domestic relations order" or QDRO, for short.
It is more difficult to split employer-sponsored defined benefit plans (usually known as company pension plans), since these type of plans typically pay only in the future. If this asset is being evaluated as part of a property settlement, a present value is usually calculated and paid in a lump sum to the other spouse from other assets. Less frequently, it is paid out only when (and if) the employee receives the benefit in the future.
One very important consideration is health insurance, especially if the planner is dealing with the nonworking ex-spouse. Once the spouses are no longer married, there is no requirement for the ex-spouse to continue carrying coverage for the former spouse unless the divorce decree says otherwise. If the ex-spouse does cut off the other spouse, all is not lost. Divorce is a qualifying event for COBRA purposes and up to 36 months of coverage may be purchased by the other spouse. Obviously, the kids' health insurance must be considered as well.
An ex-spouse may qualify for higher Social Security benefits after a divorce. Provided the marriage lasted at least 10 years and the divorce occurred more than two years ago, a divorced spouse may claim benefits based upon his or her ex-spouse's earnings record. This does not impact the benefits the other ex-spouse will receive. When filing for benefits, an astute worker from the Social Security Administration should ask about prior marriages and check to see how benefits may change if this rule applies.
In general, only marital property is divided between spouses on divorce. Separate property includes property acquired prior to marriage or gifts or inherited property received individually during the marriage. Any other property acquired during marriage is considered marital property for divorce purposes. Separate property may become marital property if commingled with marital property. State laws can vary. Spouses can alter these general rules through agreements.
Gain is generally not recognized on a transfer of property to a spouse or a former spouse incident to a divorce. (3) The transfer is treated as a gift and the transferee spouse receives a carryover tax basis from the transferor spouse. A transfer is incident to a divorce if it is made within one year of the divorce or if it is related to the cessation of the marriage. A transfer is related to the cessation of a marriage if it is made pursuant to a divorce instrument and within six years of the divorce. There is a rebuttable presumption that transfers that do not meet these two requirements are not related to the cessation of a marriage.
A transfer of property to a spouse or a former spouse in connection with a divorce is generally not subject to gift tax. A transfer to a spouse during marriage would generally qualify for the gift tax marital deduction. A transfer between spouses or former spouses is treated as made for full and adequate consideration (i.e., it is not subject to gift tax) where the transfer is pursuant to a written agreement relative to their marital or property rights and divorce occurs within the three-year period beginning on the date one year before the agreement is entered into. (4)
More households than ever fall outside the traditional opposite-sex, married couple relationship. The most commonly encountered nontraditional relationships are opposite-sex unmarried couples and same-sex partners.
According to the 2000 U.S. Census, over nine percent of American households are led by unmarried partners. Approximately one in nine of these (1% of all American households) are same-sex partner households. At some point in time, a planner will likely have a potential client that is involved in a nontraditional relationship.
There are a number of financial planning points to consider when dealing with nontraditional relationships. As more and more states acknowledge same-sex marriage or other forms of same-sex unions, the nature of a same-sex couple's legal rights regarding financial matters has become muddled. Whereas some states will treat same-sex couples the same as opposite-sex married couples, most states, and the federal tax laws, do not recognize same-sex unions for tax and other legal matters. For example:
* Federal Law
* Federal income taxes--Under current rules, unmarried couples are not permitted to file a joint income tax return. However, as a result of the much-discussed "marriage penalty," taxpayers who use the married filing joint status typically will pay more in income taxes than two working taxpayers who each file using a single filing status. Married couples cannot elect to file single; if they do not file using a joint status they are required to file separately--which often produces the worst tax result. So there is at least one positive financial outcome to a nontraditional relationship.
* Federal gift taxes--A marital deduction is only available to married couples. (3) Gifts to anyone other than a spouse are subject to the annual gift tax exclusion and lifetime unified credit.
* Federal estate taxes--A marital deduction is only available to married couples. Therefore, a married person dying with a taxable estate will pay less estate tax than an unmarried person with the same taxable estate. In fact, a married person will pay no estate tax upon death if the entire estate is left to the spouse.
* Intestacy rights--The surviving partner of a nontraditional relationship will often have no rights to a decedent's property if a will is not in place. When dealing with nontraditional relationships, it is crucial that proper and careful estate planning be performed.
* Titling of assets--One common way to protect both parties in a nontraditional relationship is to carefully title assets to ensure that lifetime wishes are carried out. Consider the following:
Joint Tenancy with Right of Survivorship
"Pay on Death" or "Transfer on Death" account designations
* Beneficiary designations--Partners in nontraditional relationships should review their retirement plan accounts and life insurance to make certain that their partners are named as the primary beneficiaries.
* Power of attorney--In order to make sure the world knows the client's true intentions, have it put in writing. A power of attorney may cover all financial or medical aspects of a person's life or may be task-specific. It may be written so it could be used immediately or so that it can be used only in the event of incapacitation or other defined event (a "springing" power of attorney).
Since many families have difficulties understanding or accepting nontraditional relationships, this is an important step in making sure that the person the client wants making crucial decisions will be permitted to do so.
Social Security--Couples in nontraditional relationships will not be able to rely on Social Security benefits like married couples do. Married spouses are entitled to claim the higher of the benefit determined under their own earnings record or one-half of their spouse's. Provisions are also in place for higher benefits for surviving spouses. Unmarried individuals must claim benefits on their earnings record alone.
Company pensions--Although company sponsored pensions are becoming increasingly rare to find, they do still exist. Some companies have made adjustments to be more accepting of alternative life arrangements. However, in many cases, a pension is paid for the life of an unmarried employee. Upon the employee's death, the pension payments cease.
CHANGE OF EMPLOYMENT
No one seems to stay employed in one place very long anymore. Gone are the days when everyone got his first job and stayed with the same company until he retired or died. People now change jobs almost as frequently as they change shoes. Company loyalty does not exist in the same fashion it did decades ago.
Companies share a large portion of the responsibility. Financial planners will rarely see a client who has a pension that is funded solely by the company. Some portion of the cost of benefits is more frequently passed on to the employee, making it more important for employees to "shop around" for the best deal for their services.
Financial planners will often be called upon to evaluate:
* the cost or benefit of changing jobs, especially where there is a change in location;
* early retirement packages offered by a company; or
* severance and job assistance packages.
The decision to accept a new job with a new employer must be made on several different levels. So much consideration needs to be given to how a job change is going to affect the employee, his or her family, and the potential for advancement, that the financial considerations may not be fully examined. Even worse, only one aspect of the finances--the salary--may be looked at, instead of the entire package.
In order to fully evaluate the financial part of the equation, a planner can assist in reviewing the value of the old job versus the value of the new. Often, this independent look can make the decision that much easier.
In addition to cash compensation or salary, a total compensation package will include some or all of the following:
* vacation time;
* retirement plan offerings, including eligibility for matching;
* health benefits, including dental and flexible spending arrangements;
* life insurance;
* disability income plans;
* dependent care assistance;
* relocation assistance;
* company car(s);
* stock bonuses, options, or other ownership programs;
* club dues;
* educational assistance; or
* business expense reimbursements.
Obviously, this is by no means an all-inclusive list. Each company will have its own summary of benefits--be sure to get the whole picture.
If there is a change in job location, it is imperative to review the state and local tax impact. More municipalities are assessing taxes on their workers, which could eat away at some of the perceived benefit of making a move to a new job.
Instead of using layoffs to cut the workforce, many companies use an option of early retirement to entice workers to voluntarily leave. These types of package are often offered with little advance notice and generally decisions must be made within a month or two of the offer.
These types of packages must be reviewed very carefully before a recommendation to accept is provided. For example:
* Are medical benefits provided in the package?
* Is the worker in any way barred from seeking employment in the same field with a competitor?
* How much of the employee's pension is lost (or increased) if the package is accepted?
* If the package is not accepted, does the employee risk being laid off or involuntarily relocated?
Severance payments are commonly provided to employees who are laid off. Occasionally, such packages are provided with outplacement assistance services. These services may include job training, placement, or financial planning.
(1.) IRC Sec. 71(b).
(2.) IRC Sec. 71(c).
(3.) IRC Sec. 1041.
(4.) IRC Sec. 2516.
(5.) Couples who are considered married under common law may be eligible to use the marital deduction.