The 42% financial hit of divorce and how to recover

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By Ted Rechtshaffen and Michelle Hung

Life does not always work out as planned, so adjustments are often needed, but one of the biggest unplanned, but not rare, situations is a marriage breakdown.

Divorces can result in an estate value being 42 per cent lower than if the couple stayed together. That may seem exaggerated, but think about it: total expenses significantly grow with two households to maintain; there are real estate commissions if a home is sold and possible mortgage penalties; and real estate and other investments may be sold at a lower price due to the forced timing of a sale, not to mention potential early capital gains taxes.

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The cost of the divorce itself is also sizable given all the legal, mediation, accounting and actuarial fees. Moreover, the emotional trauma can take a toll.

In the United States, 41 per cent of first marriages will result in divorce, as will 60 per cent of second marriages and 73 per cent of third marriages, according to Pricewaterhouse Coopers International Ltd., National Research Group Inc. and Snap Inc.

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Few couples, however, plan for one in advance. Can you imagine a financial planner sitting down with a 43-year-old couple who have been married for 10 years and the husband says, “Can we run a scenario showing what it looks like if we get divorced?”

Every situation is obviously different, but let’s use a 50-year-old couple, Sam and Jennifer, as an example. They have 14-year-old twins and a $2-million house, with a $500,000 mortgage, that was bought during their 19-year marriage.

Jennifer’s investments, savings and pension earned and accumulated during their marriage total $500,000, while Sam’s assets total $700,000. Sam is an engineer making $220,000 a year at a private company; Jennifer is a teacher making $105,000 a year and will have a pension.

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The split

In theory, the split of finances should be very simple. It involves pooling all assets earned during the marriage, including the marital home. In this case, we are making it extra simple to illustrate at a high level how it could work.

Jennifer and Sam have a combined $1.2 million to be split equally based on their respective $500,000 and $700,000 (excluding home equity) in assets. Each person would be entitled to $600,000, which means Sam would need to make an equalization payment of $100,000 to Jennifer. Sam could transfer $100,000 of his registered retirement savings plan (RRSP) to Jennifer’s RRSP tax free, regardless of how much contribution room Jennifer has.

But much can be contested. Should Jennifer take a lump-sum payment of spousal support or have it paid out over time? This lump sum is often preferred by both parties since it helps them move on, but calculating its value can be contentious.

Another big item is the after-tax value of pensions and RRSPs. There is a general rule-of-thumb tax rate that is used to determine the present-day value of the RRSP, but some people will be taxed at a much higher rate.

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The marital home

The marital home, net of the mortgage, is worth $1.5 million. Split equally, each is entitled to $750,000 in equity value. If Jennifer chooses to stay in the home, she will have to come up with $750,000 to buy out Sam.

If she refinances the house, she’ll have a new mortgage of $1.25 million, which means a monthly mortgage payment of roughly $7,300 with a 25-year amortization. This would be extremely difficult to carry and there’s no guarantee the bank would approve it. It would also make Jennifer very real estate ‘rich’ and cash poor — a situation we never recommend, but often see post-divorce.

Even with the combined child and spousal support payments (likely about $4,000 a month for now), Jennifer would struggle to sustain this mortgage, so she’ll have no choice but to sell and downsize.

Likewise, Sam would not be able to sustain this mortgage with his current salary while making child and spousal support payments.

Lump-sum agreements might help with the real estate process, but selling the matrimonial home is likely the right choice in this case.

The rebuild

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By selling the marital home and walking away with roughly $1.3 million ($700,000 from the sale of the home, plus $600,000 of investment assets) each, Sam and Jennifer have more options to begin rebuilding their financial future.

Even if each of them repurchased a smaller home for $900,000 and carried a $400,000 mortgage for the next 15 years, they’d be able to sustain these payments while investing the extra funds towards their retirement.

For someone who may not have been as actively involved with the finances before the divorce, it is important to find someone who has the financial acumen to objectively provide sound advice while being empathetic during a vulnerable time.

According to our numbers, in the example above, Jennifer would be able to retire at 62 with a full pension and an estimated estate value of $4 million by the time she’s 95. Sam would be able to retire at 65 with a $2.7-million portfolio and an estate valued at $8 million by the time he’s 95, assuming spousal support payments stop at 65 and child support payments end when the kids reach age 18.

Had they stayed together, their combined estate value would be worth $17 million by the time they’re 95 — 42 per cent more than their separated estates. Of course, different lifestyle and work decisions may reduce their estate value substantially, such as helping their children or grandchildren. Nothing in a plan stays completely static.

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But the divorce scenario still doesn’t tell the full story. It shows they would have meaningful dollars in the end, but the stress of having to sell the family home and downsizing can be extremely emotional and difficult. In addition, when assets are significantly tied up in a pension or held in RRSPs, it can make the reality of depleted savings feel like living month to month.

Easing the process

Divorce proceedings can be amicable, cooperative and cost-effective. They can also be lengthy, costly and soul-sucking. At the end of the day, you have the choice to fight for what you believe is the right thing and let go of what’s not worth fighting over.

Your children’s well-being is the utmost priority, as is your mental and physical health. The less resistant each person is, which means being responsive to lawyers and providing transparency over your finances, the sooner the divorce is settled, the less costly it will be and the sooner both can move on.

One anonymous way to help plan for such an event is to use different scenarios to determine your financial future using online tools, rather than talking to a financial planner.

Nobody starts a marriage expecting a divorce. But life is about adapting to new realities. The better you can adapt, the greater the chance you have of coming out of the divorce with a decent financial picture and some peace of mind.

Michelle Hung, CFA, and Ted Rechtshaffen, MBA, CFP, CIM, are with TriDelta Private Wealth, a boutique wealth management firm focusing on investment counselling and high-net-worth financial planning. You can contact Michelle at michelle@tridelta.ca.

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