Beneficiary Designations – Post-Divorce Financial Pitfall

Change beneficiary designations on insurance and retirement accounts immediately after divorce.

Without exception, our clients want to move on with their lives as quickly as possible after they complete the financial negotiations of their divorce. Moving on includes taking control of their own finances. There is a long list of things to do in order to take control of post-divorce finances that are beyond the scope of this article (We would be happy to send you a guide via e-mail if you request.) Our best suggestion is to enlist the services of an experienced Certified Divorce Financial Analyst® (CDFA™) professional before the divorce is final to ensure that the final agreement does not have negative long-term consequences for the client.

We regularly engage with clients to complete these items and there is one simple (to us) but infuriating (to clients) road-block that almost all face: changing or naming beneficiaries in the event of the client’s death. The first steps after divorce should include opening new retirement accounts; in most cases, this will be an IRA. New account paperwork for an IRA contains a section for beneficiary designations: the party who would inherit the account funds in the event of the account owner’s death. While married, most people want their spouse to inherit the funds in their retirement accounts; after divorce, however, the last thing they want is for their former spouse to inherit the funds in their retirement accounts should they pass on. They will often want to change beneficiary designations to their children or siblings.

Not so fast, though. If you live in a community property or marital property state, your client will need to obtain a signed consent from their current spouse to name someone else as beneficiary. In fact, most financial institutions require a spousal consent for a non-spouse beneficiary designation regardless of where the IRA owner resides. Experts believe this is simply a policy protection from beneficiary-related litigation for custodians.

Depending on a number of factors – including the divorce agreement – retirement savings accounts such as IRAs and 401Ks may require your client’s former spouse to remain the beneficiary even after they have reached agreements around the division of assets.

Planning Consideration: Timing

Many people will negotiate the date on which they will take status as single individuals for tax or other purposes. Waiting until January 1st of the year following the separation may be mandated by state-instituted waiting periods, income tax planning, insurance eligibility, or any number of other practical financial considerations. This complication provides a perfect example of an unintended consequence of negotiations: if a specific status date is negotiated into an agreement, it may have unintended consequences on a client’s financial future.

Here’s an example. The final divorce agreement for our client, Jane Smith, was filed with the court on June 30, 2012. Part of her agreement with her ex-husband, John, says they will take status as single individuals on January 1, 2013. This was done because the couple’s tax preparer advised them that they could save $2,000 in federal taxes by filing their tax return married jointly for the current year (2012).

From the federal government’s perspective, the couple remains married for the whole year – even though they have completed their financial settlement.

The agreement awards 50% (~$600,000) of John’s 401K account to Jane via a Qualified Domestic Relations Order (QDRO). In order to receive the funds, we are opening a Rollover IRA account in advance of the QDRO in Jane’s name. This way, we can tell the 401K plan administrator exactly where the funds should go and avoid any potential hiccups in the transfer process. Remember that state law, federal law, or custodian policy requires an individual name their spouse as beneficiary of retirement funds, and our client is not yet officially divorced. As CDFA professionals experienced in the intricacies of account transition, we will inform Jane that she has three options to remedy the situation and at least one to make it worse:

Obtain the former spouse’s signature on a Spousal Consent for the new account paperwork. John must effectively agree to allow Jane to name her children as the beneficiary of the funds she was just awarded in the divorce.
1. Client Quote: “You mean I just spent 18 months and $50,000 fighting over this money and I still need his permission to do what I want with my money?!”
2. Practical Consideration: What if the relationship has deteriorated to the point where John refuses to agree to the change in beneficiary? It may cost thousands of dollars in attorney fees to force her to do so.
3. Practical Consideration: What if Jane doesn’t want John to know who her financial advisor will be post-divorce?
4. Name the former spouse as beneficiary temporarily. In really bad circumstances, when a couple no longer communicates at all, it may be advisable to simply name the former spouse as beneficiary with the intent of modifying this as soon as the judgment is final.
  1. Client Quote: “You mean we have come all this way and I have to keep him as my beneficiary and he will inherit my money if I die?!”
  2. Practical Consideration: What if we decide to postpone but somehow forget to change the Beneficiary Designation once the judgment is final? Does the judgment awarding the 50% to Jane protect her?
  3. Practical Consideration: What if something happens while the judgment is pending? Who inherits Jane’s money?
  4. Delay the transfer of funds. QDROs take time: the QDRO cannot be carried out until the final judgment is signed by a judge, and it is rare to see a QDRO completed in close proximity to a judgment of dissolution.
    1. Client Quote: “But you said ‘Taking Control Now’ was the most important part of my financial transition after the divorce! Now you are telling me to wait?! Wait for what?!”
    2. Practical Consideration: So what is the harm in waiting? Our major concern is the management of investments inside of the account. When transfers are delayed, the funds are often managed by the former spouse or by an investment advisor my client has explicitly chosen not to work with. I recently had a client tell me they would never invest in such a risky asset as the Facebook Initial Public Offering (IPO). Imagine her shock when I showed her the most recent account statement for her joint brokerage account and her investment advisor had purchased 3,000 shares of Facebook in the IPO! The advisors used by a couple during marriage are rarely appropriate for both parties – particularly the woman – to work with after a divorce. Either they will be aligned with one party, unfamiliar with the specific needs of a newly-divorced woman, or unable to provide the necessary services. On top of that there is often a lack of trust. Without trust, an investment advisor has no business working with an individual.
    3. Practical Consideration: I have seen investment accounts lose half of their value during dissolution proceeding. Guess who gets blamed for the losses? Usually the former spouse – which means the client may not trust anything they have to say and turn into thousands of dollars of additional unnecessary discovery efforts.
    4. Practical Consideration: We may want to obtain Authorization and Consent from the former spouse for our client to take over managing her portion of the funds.
    5. Ignore the problem. We certainly would not recommend this option – and we would also be remiss if we failed to mention the ramifications of doing so.
      1. Client Quote: “He has been jerking me around and lying to me for years. What is the worst that could happen?”
      2. Practical Consideration: We actually don’t know what the ramifications would be of disobeying from a legal perspective.
      3. Practical Consideration: We do know if no spousal waiver has been obtained, the default plan beneficiary will be the participant’s spouse, even if he is not the named beneficiary. US District Courts have affirmed this. In this particular case, John – not Jane’s chosen beneficiaries: her children – would inherit the retirement funds if Jane should pass.
      4. Practical Consideration: There is a bit of uncertainty and disagreement amongst experts whether these rules are equally as hard-and-fast with IRA accounts as they are with 401K accounts. The presence of uncertainty makes experienced financial advisors plan for the worst-case scenario, so ignoring the precedent is never presented as an option for our clients.

The financial transition following divorce offers the opportunity for clients to remake their financial lives in a way that supports their ongoing comfort, security, and dreams. Most importantly, it offers the opportunity to take control of their finances as a single individual and throw off the constraints of a power-struggle now terminated by a judgment of dissolution. The complications of such simple things as paperwork, as evidenced above, can have prolonged and lasting effects on your clients’ lives when the power-struggle continues after the financial agreements are reached. Enlisting the services of an experienced CDFA professional during the process will help ensure your clients obtain the most financially advantageous settlement possible and support their financial independence far beyond divorce negotiations.

At Wellspring Divorce Advisors we are experts and international leaders in the field of Divorce Financial Planning. Contact one of our advisors today for an experienced and professional guide through your post-divorce transition and help considering your beneficiary designations.

California Divorce Myths

June 13, 2012/in California Divorce Dictionary, Divorce Financial Planning /by Justin Reckers

Everyone has a friend or family member who has been divorced. Many will have heard horror stories or received tips about what they should do or what they should expect. I have heard “Mom always gets the kids” and “I earned the pension so it’s mine” People also make up there own expectations like “I made all the money, so I’ll get all the assets” or “I’ll get half of everything”. Here is a list of the top 11 Divorce Financial Planning Myths that come to my mind.

1. “I made all the money, so I’ll get the assets”
2. “Dad has to pay for college”
3. “Mom always gets the kids”
4. “Child support will take care of us”
5. “My spouse charged up the credit cards- they are not my debts”
6. “I’ll always get spousal support”
7. “We have small kids, so Mom gets the house”
8. “I earned the pension so it is mine”
9. “The courts will take care of me”
10. “I’ll get half of everything”
11. “We have no fault divorce in California so it must be easy”

Annuities and Your Divorce

March 23, 2012/in Divorce Financial Planning /by Justin Reckers

Following are excerpts from an article ran in the March 19th 2012 issue of Investment News. It underscores one of the many pitfalls of divorcing without the help of a financial expert. Unexpected penalties, fees, taxes and charges can wreak havoc on a post divorce financial plan.

Breaking up is hard to do – especially with annuities

Attorneys often split contracts in divorce settlements, unaware of the potentially costly impact

By Darla Mercado

When a client came to his office bearing her new divorce decree, adviser Dale Russell became the bearer of bad news. During the divorce proceedings, the couple’s lawyers decided that their chief financial asset, a $500,000 variable annuity inside one of their individual retirement accounts, was to be split among the two. But that Solomon-like decision was made without the attorneys’ awareness of its dire financial consequences.

Splitting the variable annuity meant that Mr. Russell’s client had to pay an 8% surrender charge and a 10% penalty for an early withdrawal from the IRA.

With nearly one in two marriages ending in divorce, financial advisers who deal with divorcing couples often face complex problems connected with untangling annuities that are in the pool of shared assets.

With divorce attorneys typically unaware of the nuances of annuity contracts and the various ways insurers treat contracts in the context of divorce, and with advisers typically out of the loop when settlements are hammered out, the problem lands in the lap of advisers.

“This was essentially the only asset they had, and instead of my client’s getting the $250,000 she expected, she’s getting almost $50,000 less,” he said,

“It’s a big problem, said adviser Lili A. Vasileff, president of Divorce and Money Matters LLC and president of the Association of Divorce Financial Planners Inc. “Most attorneys think these annuities can be divided, and don’t wait for the consequences.”

Couples who work out divorce agreements on their own are even less likely to consider the financial consequences of splitting an annuity, and typically face surrender charges and loss of accrued living or death benefits due to excess withdrawals.

What makes annuities peculiar is the fact that they usually are not liquid in the immediate term, and each contract has its own rules on how it can be divided.

Contract Terms

Contract terms vary wildly among insurers, with some prohibiting partial tax-free exchanges into other annuities, which potentially could be a way to apportion an annuity in a divorce. Exchanges into a new annuity, however, generally involve the beginning of a new surrender period.

Ideally, an adviser would intercede early in the split, analyze the shared pool of assets and communicate with life insurers about the annuities. This would also entail ensuring that if an annuity split involved a partial Section 1035 exchange, the division would be performed without the risk of taxes.

It pays to be attentive to these details, advisers said, as insurers adhere strictly to the terms of the divorce decree.

“If the court says the contract needs to be split a certain way, we have our hands tied,” said Brian L. Kunkel, national director of advanced planning and solutions at Prudential Financial Inc.

“If the client calls us, we can outline the options available to comply with the court agreement and still be as contract-friendly as possible,” he said. “If people just process the agreement, then we merely follow the instructions.”

In most cases, a divorce decree absolves the attorneys involved from responsibility for any financial consequences.

Social Security and Divorce Financial Planning

March 7, 2011/in Divorce Financial Planning, Gray Divorce, Post Divorce Financial Planning /by Justin Reckers

Social Security in the United States refers directly to a lesser known federal Old Age, Survivors and Disability Insurance program or OASDI. The program was originally rolled out in the 1930’s in an attempt to limit what were seen as dangers to the American way of life such as increased life expectancy, poverty, and fatherless children. So the Social Security Act, signed in 1935, created social insurance programs to provide benefits to retirees, the unemployed, and as well as a lump sum benefit to the family at death. Many amendments have been made since the original Social Security Act of 1935. Most importantly; Medicare was added in 1965. The Social Security Act of 1965 also recognized for the first time that divorce was becoming a common cause for the end of marriages and added divorcees to the beneficiary list.

The largest component of benefits is retirement income. Throughout a person’s working life the Social Security Administration keeps track of income and taxpayers fund the program via payroll taxes also known as FICA (Federal Insurance Contributions Act) taxes. The amount of the monthly benefit to which the worker is entitled depends upon the earnings record and upon the age at which the retiree chooses to begin receiving benefits. FICA taxes are 7.65% for employees and 15.3% for self employed individuals. The amount of taxes paid is not directly used to calculate an individual’s benefit. The rate is broken down into two parts: Social Security and Medicare. The portion is 6.2% and is paid on a maximum of $106,800 of income for 2009. The income maximum is also known as a wage base. The Medicare portion is 1.45% on all earnings. These rates are set by law and haven’t changed since 1990. The wage base for Social Security is indexed each year for inflation and Medicare has maintained an unlimited base since 1993.

Self employed person’s pay double the amount of tax because the employer is responsible for the other half of an employee’s liability. A self employed individual is both employer and employee. There are wages not subject to FICA taxes including some state and local government employees who participate in alternative programs such as CalSTRS and CalPERS. Each state and local government unit with a pension plan decides whether to elect Social Security and Medicare coverage. Civilian federal employees are covered by Medicare but usually not Social Security.

The earliest age at which reduced benefits are payable is 62. The age at which full retirement benefits are available is dependent upon the taxpayers age. An increase of regular retirement age was enacted to reduce the amount of benefits payable. For those currently over age 70 the normal age was 65. Anyone born after will fall somewhere on increasing scale which climbs incrementally to age 67 depending upon birth date. Anyone born after 1960 must reach age 67 for normal retirement benefits. Delaying receipt of benefits will increase a taxpayer’s benefit until age 70.

Benefits are paid from taxes collected from other tax-payers. This makes it a pay as you go system and will eventually be directly responsible for the downfall of the program. At least as we know it today. In 2009, nearly 51 million Americans will receive $650 billion in Social Security Benefits. Economists project that payroll taxes will no longer be sufficient to fund benefits somewhere in the next 10 to 15 years. Once we can’t cover the expense from cash flow, the program will begin drawing down the trust fund it has accumulated during times of surplus taxes. We can only speculate what happens when the trust fund runs out. This is the cause for concern often discussed in the news and other media. The fix for this problem is the subject of much political posturing including that witnessed in President Bush’s 2005 State of the Union address.

The first reported Social Security payment was to Ernest Ackerman, who retired only one day after Social Security began. Five cents were withheld from his pay during that period, and he received a lump-sum payout of seventeen cents from Social Security. This might give you an indication of how Social Security handles business.

A current spouse is eligible to receive survivor benefits equal to 100% of the deceased worker’s benefit if they have reached normal retirement age.

Divorced spouses are eligible for benefits equal to one half of the worker’s benefit if they were married for 10 years have not remarried and are at least 62 years old. This is called a derivative benefit. A spousal applicant must wait until the worker has reached retirement age, 62, in order to apply for benefits. The worker is not required to have applied for benefits in order for the ex-spouse to apply for spousal benefits. They are not entitled to increases for benefits taken after normal retirement age. If a worker has died and the ex-spouse has reached full retirement age they can receive 100% of the worker’s benefit as survivor benefits.

If an applicant is between age 62 and their normal retirement age; the application for benefits will be based on the applicant’s earnings record. If one half of an ex-spouse’s benefit is greater than the applicant’s benefit on their own record; the applicant can choose to take whichever is greater. If you wait until your normal retirement age and file for spousal benefits you can continue to accrue benefits and enhancements for delaying your own retirement up until your age 70.

An ex-spouse’s receipt of derivative benefits on the worker’s record does not reduce the worker’s benefits. It is even possible for more than one ex-spouse to collect on the worker’s derivative benefits. This could lead to as much as 500% of the original benefit being claimed by the five ex-spouses.

Windfall Elimination Provision and Government Pension Offset Provision

For those worker’s who are covered by a pension based on their own earnings not covered by Social Security a different method of computing benefits applies. The alternative method is called the Windfall Elimination Provision (WEP) and was created to close a loophole that enabled worker’s who earned benefits in covered and non-covered employment from being labeled a low-earning worker and receiving a disproportionately large Social Security benefit.

The formula is weighted in favor of low earners because such a person is more dependent on Social Security. If the WEP is applicable it reduces a worker’s Social Security benefit by 50% of the worker’s pension benefit up to a maximum of $380.50 in 2010.

If you earned a pension based on work where you did not pay Social Security taxes, your Social Security spousal or derivative benefits may be reduced. The Government Pension Offset Provision (GPO) was enacted to treat retired government employees who had not contributed to Social Security similarly to retirees who had. The GPO reduces derivative benefits by two-thirds of other government pensions received. This can reduce Social Security benefits to zero.

The truly important ramification of the WEP and GPO on Social Security retirement benefits comes into play during divorce proceedings. Federal Law makes Social Security benefits the separate property of the party that earned them.

They are not assignable or divisible in a family law court and not considered an asset of the community in California.

Government and other pensions, on the other hand, are considered community property in the state of California to the extent benefits were earned during marriage. Derivative benefits under the Social Security program for ex-spouses would seem, at first glance to remedy the problem. The non-worker spouse get’s half of the worker’s retirement benefit via derivative benefit payments. Getting to the true ramifications of the WEP and GPO during divorce proceedings requires sound financial planning.

Consider the following couple.

– Jim was a private employee covered by the Social Security system. He retired at age 66 with a monthly Social Security benefit of $2,014.
– Barbara has been employed as a teacher for 30 years covered by the California State Teacher’s Retirement System. She retired this year at age 65 with 30 years of service under CalSTRS and a monthly benefit of $5,520 without having paid a single penny into Social Security.
– Barbara’s CalSTRS benefits are considered community property in California having been earned entirely during marriage.
– Jim and Barbara are divorcing and her CalSTRS pension will be divided equally with each party receiving $2,760.
– Jim will continue to receive his $2,014 per month of Social Security.
– Barbara will be entitled to a derivative Social Security benefit equal to one half of Jim’s benefit, $1,007, or the benefit she has earned on her own record. Barbara has not earned a benefit on her own record so she will choose to receive the derivative benefit on Jim’s record.
– The Government Pension Offset will reduce Barbara’s Social Security benefits by two thirds of her $2,760 pension benefit, or $1,839.82. The GPO leaves Barbara with $0 from the Social Security derivative benefit.
– Barbara will receive a total of $2,760 from her CalSTRS Pension and $0 from Jim’s Social Security derivative benefit.
– Jim’s Social Security benefits will not be affected by the GPO or WEP.
– Jim will receive $2,760 from Barbara’s CalSTRS benefit and $2,014 from his Social Security retirement benefits for a total of $4,776.

What looks to the lay person to be an appropriately arranged method for completing an equal division of assets leads to a grossly in-equitable settlement that provides Jim with $4,776 per month and Barbara with $2,760 per month.

The California Federation of Teachers sponsored a rally on November 7th 2009 to urge Congress to pass SR 484 in the Senate and HR 235 in the House of Representatives to repeal the Government Pension Offset and Windfall Elimination Provision. This has been attempted numerous times before without success. Social Security is a monster of finances, public policy and entitlement. Making changes is not easy or quick.

Consulting with a qualified financial planner experienced in the nuances of divorce finances and retaining their services as a neutral expert or advisor will help divorcing individuals work with and around in-equities caused by the system.