December 1, 2015
As we all know the divorce process can take a few months at best, and in some cases years. Once an agreement is in place it then takes a couple of months for the court to approve the documents. When dividing investment accounts, the decree and other forms have to then be given to the account custodian to process. Therefore a spouse who is awarded an investment account in the divorce may not take actual possession of that account for some period of time. This is especially true for 401(k)s, 403(b)s and other company-sponsored accounts that require a QDRO, as the drafting and approval process often takes 6-12 months.
During this time investment accounts are subject to market volatility. In some cases the account value can be markedly different at the end of negotiations than it was at the beginning of the process. This can have a profound effect on the financial outcome for the parties.
In addition, even after the divorce is finalized the parties are not always diligent about dividing the investment accounts. That means an account that should now be managed by the receiving spouse is still under the name of the giving spouse, who may have the account invested in a manner that is more or less aggressive than the receiving spouse would like. Again, market gyrations may affect the account value. If the account goes down in value, it’s possible it will be worth less than what was supposed to be transferred to the receiving spouse.
It’s true that as long as accounts are divided by percentage both spouses will participate equally in market ups and downs. However it doesn’t take away the fact that the actual dollar value each spouse ends up with could be significantly less than what would have received if the accounts had not lost value.
Dividing accounts by percentage is preferable to awarding a specific dollar amount to a spouse. Recently I was involved in a case in which the parties came to agreement in September 2014 yet the husband’s IRA still has not been transferred to the wife as of this month. During this period the account lost 13% in value, and is worth less than the dollar amount that was supposed to be transferred to the wife. The couple will be meeting with their collaborative divorce team to come up with a solution to this problem.
You can safeguard against the potential problem caused by market losses by removing some or all of the potential for loss from the investment accounts during the divorce. There are several ways to do this.
First, all of the securities in the account could be cashed out, and the cash left in the account. It won’t earn much after this happens and the risk is that the owner loses potential gains, but this is the best way to preserve the value. Alternatively a target-date or balanced mutual fund could be purchased. These types of funds have a mix of stocks and bonds and it’s easy to find one with a very conservative mix of primarily bonds.
This is an easy solution for any tax-deferred account including an IRA, Roth IRA, 401(k), 403(b), SIMPLE IRA or SEP-IRA. You could even do this for a deferred annuity. If you cash out a taxable account however, you may generate capital gains that are taxable. Depending on the amount of gains this may not be an attractive choice. There is no alternate solution here other than to consult an accountant and look for ways to offset the capital gains.
Another solution is to have both spouses agree on the percentage of stocks, bonds and cash that they would like for the investment portfolio during the divorce proceedings. Perhaps both parties agree that they don’t want to cash everything out and lose the possibility of stock market growth, but they want the investments to be invested more conservatively. They could agree on the mix and then invest each account to match that mix.
This issue should be addressed at the beginning of the process for every couple that has investment accounts. In this manner you can remove the risk of investment losses that can negatively impact a divorce settlement.
