Financial Case Study
John and Jane are getting a divorce. What makes most sense for them in terms of a property settlement? It depends – it depends on their situation, and on the advice they get from the professionals assisting them.
John and Jane are both 40 years old. They have two children and own a home worth $165,000 that has net equity of $77,500. Their IRAs and 401(k) retirement plans are currently worth $165,500.
John earns $90,000 a year and has take-home pay of $68,760 a year. Jane has never worked outside the home and has limited marketable job skills. Her plan is to somehow make do with the settlement plus a job that pays $7 an hour and take-home pay of $14,500 a year.
The following settlement has been suggested:
After the divorce, Jane and the children will live in the house, which will be deeded to her. She will also receive $44,000 of the present value of the retirement money, and John will receive $121,500. In other words, the assets will be divided equally. John will pay Jane alimony of $600 per month for 5 years and child support of $225 per month per child. He will also pay college costs when the children start higher education in 4 years.
John's expenses include his normal living expenses, child support, alimony and college costs. Jane's expenses include support of the children and are reduced when each child leaves home.
What could be wrong? This appears fair.
What is wrong is clearly demonstrated in the following graph. In this simple scenario, Jane's assets will be completely depleted within seven years while John's investments will grow dramatically.
John is not out to hurt Jane and his children. He wanted “fairness,” and that’s what this settlement seemed to provide. But guess what? Jane is in a perilous situation, and it will prove very difficult to get her out of it.
What should have happened?
Someone with financial expertise should have looked at this settlement and explained to the parties where it would lead.
To improve Jane's financial future, the settlement could have provided her with alimony of $1,500 per month for 10 years. This would cost John $1,005 per month in after-tax dollars. A more realistic child support payment would be $1,125 per month for two children for a couple with their income.
If fairness is the goal, Jane should be awarded an additional $24,300 from the retirement plans. She also needs to make some changes. She may need to cut her cost of living by 10%.
Had these changes been incorporated in the original settlement, the results would have been dramatic. John would still have a surplus to add to the value of his investments. If John stays within his budget and invests all of his extra income, his investments have the capacity to grow to $2.5 million by the time he is age 60. Not bad.
This sample case illustrates the value of financial planning as a means of reaching more equitable divorce settlements. And they are achievable in a way that doesn’t unduly disadvantage either party. What is needed is foresight. And expertise.
If the court's intent is to treat both parties in a divorce as equitably as possible, it is essential to analyze the marriage as if it were a financial contract, with each party making reasonable and meaningful tangible investments.