Creating a Divorce Settlement Agreement, Part 1

Adapted from an article by Nancy Kurn, CPA, CDFA™, JD, MBA

You’ve sat down with your spouse and hammered out what you think is a pretty great settlement: you get to keep all of the property you really wanted, and your ex gets stuck with all of the debt. But whether or not that agreement will hold up in court depends on a number of factors, including how it is worded, whether or not there was full financial disclosure by both parties, and possibly whether both parties had independent legal counsel.

That being said, you should make every effort to negotiate your settlement agreement rather than fight over every item in court. Such agreements have several benefits over a judge’s ruling including: they take less time; they reduce the financial and emotional costs; and the parties are more likely to abide by the terms of the agreement.

If you’re able to put aside your emotions and focus on the issues at hand, the chances of negotiating a settlement are extremely high. A courtroom is simply not the right venue to express your feelings of anger or loss, so find a counselor or a support group to help you work through your emotions so you can be as clear-headed and practical as possible during negotiations with your spouse. Some couples will be able to settle all issues; others will be able to settle some issues and have to litigate the rest.

Your settlement agreement will need to thoroughly address spousal or child support as well as custody and visitation issues.

Your settlement agreement should be very comprehensive – particularly with regard to how the property is divided. Once you sign an agreement regarding property division, it cannot be changed unless both of you agree to the changes. It’s up to you to make sure that your lawyer doesn’t leave any assets out of your settlement agreement (unless it’s something that you’re going to litigate in court).

You don’t necessarily have to list every single personal possession in your settlement agreement, but you should list personal items that are important to you. You should also list financial assets, including retirement assets and real estate.

Your agreement should state who gets each asset or how the asset or the proceeds from its sale will be divided.

First an examination of the financial assets.

Financial Assets

Financial assets include cash, savings accounts, checking accounts, Certificates of Deposit, money-market accounts, stocks, bonds, Real Estate Investment Trusts (REIT), mutual funds, and savings bonds. These assets may be more important to the non-working or lower-income-earning spouse. He or she may need to use these assets to cover some of his or her living expenses.

Retirement Assets

Remember that not all assets have the same tax consequences. Retirement assets are generally before tax assets. This means that in order to access the money, you have to pay income tax on any distributions you receive. In some cases, you may also have to pay a penalty on the distribution in addition to any income tax that you pay.

For example: Mary suggested to Gus, “You keep your retirement assets, valued at $100,000, and I’ll take the money-market account, valued at $100,000.” Gus agreed because it was an equal division of the assets. However, when Gus retires in 2009, he will pay tax on the distributions. So if Gus pays tax at a rate of 25%, then he would end up with only $75,000 versus the $100,000 that Mary received.

In the U.S., there are many different types of retirement assets, including defined benefit plans, defined contribution plans, IRAs, and Roth IRAs. It is important that you determine how defined benefit plans, such as pensions, will be divided between you and your spouse. This is generally spelled out as a percentage of the retirement benefit at the time of the divorce. It is also imperative for the agreement to state if the employee’s spouse will be entitled to survivor’s benefits if the employee dies. It is important to make sure that the non-employee in fact qualifies for survivor benefits; otherwise, he or she may be better off with another asset.

Defined contribution plans include 401(k) plans, profit-sharing plans, simple IRAs, and other types of contributory plans. Generally, these can be divided today, and the non-employee spouse can take the percentage that is awarded and roll it over an IRA or perhaps maintain it as a separate account in the same plan. The agreement should specify the percentage that you and your spouse will receive.

IRAs or Roth IRAs are also easily divisible. Remember that distributions from Roth IRAs will generally not be taxed, while distributions from IRAs will generally be taxed. As a result, $10,000 from a Roth IRA is probably a better asset than $10,000 from an IRA.

Employee Benefits

In addition to retirement plans, many employers provide other fringe benefits and incentives to their employees. These benefits include year-end bonuses, accrued vacation time, accrued sick time, health insurance, life insurance, disability insurance, expense accounts, stock options, and more unusual benefits such as Phantom Stock, Stock Appreciation Rights, and Restricted Stock.

Some of these benefits may be included in your list of assets; other benefits may be included as income, and some may not be included at all. Determining if a benefit should be treated as a marital asset, income, or nothing at all can be very subjective. Different jurisdictions and judges may view the benefits differently. As a rule of thumb, if the benefit is guaranteed, then it should be included as an asset or as income. A year-end bonus could arguably be an asset, an income item, or nothing at all if it is not guaranteed. For example: Barbara and Jeremy were married for 15 years. Jeremy, the employee-spouse, received a bonus every year. Barbara could certainly make a reasonable argument that it is an asset or income for purposes of calculating child support and alimony. Vested stock options would also be an asset; with the changes in the market, they may not have any value, while unvested stock options, on the other hand, may not be an asset.

Personal Property

List your personal possessions, particularly those that are important to you, and note how they are going to be divided. This would include big-ticket items, such as cars, boats, and motor homes, as well as items such as jewelry, furniture, photos, and personal papers.

Keep the value of these assets in perspective – and recognize when it’s time to give up the fight. We’ve all heard of those cases where parties spend thousands of dollars fighting over an asset that’s worth less than $100.

Each spouse should keep copies of joint tax returns. We recommend that you keep at least the past five years; in addition, you will need records to calculate the cost basis for any assets that you keep.

Real Estate

Real estate includes your marital home and any other homes, vacation properties, timeshares, and rental properties – commercial and residential – as well as any business property. The properties should be listed, and the settlement agreement should address how they are going to be divided.

If the property is going to be sold, the following issues need to be addressed:

Who is going to pay the expenses until the property is sold?
How will the proceeds be divided?
If one spouse pays the expenses, will he or she be reimbursed, from the proceeds, before they are divided?

Debts

Generally, the person who takes the property will be expected to pay the mortgage or debt related to the property. Does this mean that the other spouse has no financial obligation for a joint debt? Absolutely not. Unless the spouse who takes the property refinances the mortgage, both spouses will still be obligated to pay the debt. The divorce decree cannot terminate your financial obligation to your creditor. For example, Bob and Amy are dividing their assets as shown in “Table One” (below).

After the divorce, Bob would be liable for the car payment and Amy would be liable for the mortgage. If either neglected his or her payments, the other spouse would still be liable. But if Amy and Bob refinance after the divorce, the other spouse will no longer be liable for the debt.

Requiring the other spouse to refinance after the divorce is something that should be put in the settlement agreement. They could, for instance, allow a certain time period to refinance. If they do not refinance or do not qualify to refinance, then the asset could be sold and the loan could be paid off with the proceeds from the sale.

If only one spouse is obligated on the debt during the marriage, then the other spouse cannot be held liable. This occurs most frequently with credit-card debt. However, if it is a joint debt, then just like the mortgage, if one spouse is responsible for paying the joint credit-card debt pursuant to the terms of the settlement agreement, this does not mean that the other spouse is no longer responsible for the debt. Unfortunately, both spouses will remain liable to the creditor. If one spouse refuses to pay, then the other spouse will have to pay off the debt. If you can afford it, paying off credit-card debt with liquid assets is the best way to deal with unsecured debt.