Understanding the Long-Term Impact of your Financial Decisions
One of the most common money mistakes that people make during legal settlements, such as divorce, is not fully understanding what assets may yield 10, 15, or more years down the road. Someone may think that getting to keep the large 401(k) account or the marital home is a win, or that just splitting assets 50/50 is the way to go. But because these assets can grow or lose value over time, it is important for people to understand the long-term impact of these decisions on their overall future financial plan and lifestyle. Being able to visualize the long-term outcome will help you through the emotional turmoil of divorce and maximize the benefit for your family. Often clients want to stop having their financial plan updated when they are going through a divorce but this is typically the most important time to plan for your future. So, how do you determine which assets will be more beneficial for you in the long-term, and why? Let’s take a look at a few of the biggest.
Remember that not all retirement accounts are created equal; that’s why it’s so important to have some background in projecting asset growth when making decisions on which retirement assets will be most beneficial to you.For example, if you are a higher-wage earning spouse who is no longer eligible for making Roth IRA contributions, it might be more beneficial for both spouses that the higher-wage earner keeps the Roth IRA, as opposed to splitting it straight down the middle. The lower-wage earning spouse may still have an opportunity to make additional contributions, which maybe a greater benefit in the long run. Roth contributions are tax-free when they are used in retirement, so it would be a more advantageous asset for the higher-wage earner to have than say, an old 401(k), which is pre-tax money. Funds coming out of a 401(k) in retirement would be taxed at that time. Because the higher-wage earning spouse has earned out of the opportunity to contribute, it might be worth it to give up more pre-tax money (in the form of a 401(k), for example) to the lower-wage earning spouse. This is just one example; the idea is to understand that it may be beneficial to give up some taxable funds to gain more tax-free assets, or vice versa, depending on your situation. Either way, splitting things right down the line might not always be best for either of you. It’s all about determining which asset is better for your personal situation. The hard part is making the projections and putting in different “what-ifs.” But if you can start understanding how the future might look given a reasonably fair outcome the easier it will be to keep your emotions in check when it comes to the finances.
For the lower-wage earning spouse, it might be better for you to take a greater portion of a pension asset because it is a guaranteed income stream for your future. I’ve found that it is sometimes hard for people to wrap their heads around how beneficial that amount of money could be in the future. When clients are going through a divorce, the 401(k) asset can seem like a big, shiny number that is far greater than what the pension appears to be at the time. In their emotional state, they may think that it is better to keep the 401(k) when in reality, the pension asset will serve them better in the long run. It’s important to understand that there are very few other guaranteed income streams. Many pensions even come with an annual cost of living increase.
Many times, one or both of the spouses want to keep the marital home. And so often, this is not the right move for either spouse. Through the divorce, you’re essentially taking the resources that it took to run one household and dividing them in a way that is supposed to now support two. More often than not, it simply doesn’t work, financially speaking, to keep the home. Especially for the lower-wage earning spouse, it’s important to realize that getting to keep the house is not the end of the road. You still need to save for retirement, but the expense of keeping the house ends up being simply too big an expense and there is no money left to save. I’ve seen it happen many times, when a year or two after a divorce, you’re forced to sell the house that you fought so hard to keep during the divorce. Of course, this can be a very emotional decision and many people are focused on fighting hard to keep the marital home.
There’s often a fear of uprooting children from their home and you feel you need the house to help with the children’s emotional stability. In reality, home is where your family is, and keeping the house when you really can’t afford it is just going to cause greater strain on your emotional state. The key is to keep planning for your future just from your new vantage point. Including your Financial Advisor in the process may help lower your fears regarding your future and help you make better decisions.Illustrations are the way to get the emotions out of the way and focus on the numbers and your future.
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