Show me the money!

August 1, 2016

After a divorce is completed one or both of the parties may have an immediate need for cash. There are various reasons for this, including:

• The need to compensate one spouse for assets given to the other spouse
• To enable one party to purchase or make a down payment on a house
• To enable one party to buy out the other party’s equity in the house
• To allow one spouse to go back to school or obtain professional certifications

Coming up with cash is not always easy. In my experience most of the couples I have worked with are not sitting on a pile of cash in the bank. However, there are a few ways to tap into the estate and generate the needed money.

Refinancing the home. Usually the biggest asset the couple has is the equity in their home. In order to create a fair settlement some of that equity needs to be shifted from one spouse to the other. Refinancing the mortgage to take out some of the home equity is one way to find cash. Unfortunately this is not always possible, especially for a spouse who has low income, a short history of alimony or child support payments (up to 24 months of income is required by some banks) or a poor credit history. Working with a good mortgage broker is important in these circumstances.

A home equity loan or line of credit is another possibility. Like refinancing, the homeowner will have to pass some qualification parameters.

For homeowners over the age of 62, a reverse mortgage is a tool that allows the equity to be accessed without the need to make loan payments. As long as the homeowner lives in the house the loan interest will accrue, and is paid back when the house is sold. Reverse mortgages are regulated by the government and should be used only after careful consideration.

Tapping into retirement accounts: Often the parties look to their retirement accounts for cash. There are a number of ways to access cash here:

• A withdrawal can be taken from an IRA or SIMPLE IRA, although taxes and sometimes penalties (if the owner is younger than 59 ½) may be assessed. If this is part of the plan then be sure to factor taxes and penalties into the calculation of the amount to be withdrawn.
• Even though IRA distributions (including SIMPLE IRAs and Roth IRAs) carry a penalty for withdrawals before 59 ½, there is a way to take money out without this excess charge. IRS rule 72t permits withdrawals from a retirement plan without penalty if the money is withdrawn in substantially equal payments for 5 years, or until the owner is 59, whichever is longer. There are several different formulas that can be used to calculate the amount that must be withdrawn, and no more nor no less can be taken from the account during the 5 years. It is important to work with one’s accountant when making this calculation.
• Roth IRAs allow the withdrawal of principal – the amount contributed to the account – without tax as long as it has been 5 years since the Roth was opened and had the first contribution.
• Most 401(k) plans do not allow withdrawals while the employee is still working at the company but they will allow loans. Check with the employer to find out the interest rate applied. The loan is paid back through the employee’s contributions, or may be able to be deferred until the employee retires (although interest will accrue.)
• In a situation of divorce it is possible for a spouse receiving part of his or her ex-spouse’s 401(k) plan to take a one-time withdrawal. They will owe income taxes but, if the receiving spouse is under age 59 ½, he or she can avoid the extra 10% penalty. There are many details involved in this strategy and you should consult a divorce professional.

Tapping into taxable investment accounts: If there is a taxable brokerage account, such as a joint investment account, the owner may be able to borrow on margin. This means the owner can borrow an amount based on the value of the securities in the account. This is appealing to those who don’t want to sell their securities but need cash. While margin balances can be carried for an indefinite period (although interest is charged), it is important to know that a margin loan can be “called”, or required to be paid down, if the underlying securities fall below a specific value.

It is imperative to consult with a Certified Divorce Financial Professional or accountant before using any of these strategies so that there is a full understanding of expenses, taxes and penalties.

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