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Divorce Planning

by Gary Foreman
The Dollar Stretcher

Dear Dollar Stretcher,
A year ago my husband of 17 years asked for a divorce. After many dollars to my attorney and a Certified Divorce Planner it appears a settlement is near. Should I use the divorce planner as my financial planner? I will have a lump sum settlement of approximately $300K and no debt. Child support will be around $2000 per month for two teenage boys (13 & 15). I have lots of questions about how best to handle a settlement that is 50% a QDRO, 25% stocks and 25% cash.
Starting Over again at 47

Starting Over is not alone. U.S. Federal government statistics indicate that there will be nearly 1 million divorces this year. And she's wise to be concerned with finances. According to the Census Bureau, in 1998 there were 3.8 million women headed households living below the poverty level. Obviously not all of them are divorced. But it does show how hard it is for a single parent to keep afloat financially.

She will need to pursue two types of financial planning - budget planning and also investment planning. The planner she chooses should be versed in both areas. One advisor is best since the plans are inter-related.

She'll need to start with a budget. Using last year's income and expenses as a guide, she'll estimate a new budget without her husband. She'll find that expenses will drop in some areas. Clothing, for instance. But many expenses will probably stay just about the same. Utilities, property taxes, and homeowner's insurance won't change much.

Housing is a critical expense. She will need nearly as much living space as before. Starting Over should try to keep housing to less than 35% of her after tax income. That may mean moving to a smaller or less desirable home.

Some expenses will go up. Medical insurance is one potential problem. She could lose coverage through her husband's plan at work. Even if he's responsible for the boys, Starting Over will need insurance for herself.

In the U.S., she can use COBRA to buy a policy, but she'll pay the premiums. Once a budget is roughed out, Starting Over will have a clearer picture. Like the rest of us, she'll need to keep expenses under income. If she doesn't she'll quickly consume the settlement. And she should remember that child support isn't always dependable. Reports indicate that less than half of all child support payments are received on time and for the full amount.

Starting Over will also need to prepare for some major milestones. An important one is college for the boys. Although costs vary significantly she can expect to pay about $10,000 per year for a public university. And that goes up about 5% per year.

She's fortunate to take a nest egg with her. That money can be used to provide monthly income or saved for major expenses like retirement.

It's not surprising that 50% of the settlement comes through a QDRO (Qualified Domestic-Relations Order). That's a court order that awards a share of a pension plan to a divorced spouse. She won't necessarily get a check immediately. It's even possible that she won't begin to receive payments until her ex-spouse retires.

There are three key concepts to investment planning for Starting Over. They are:
  • risk vs. return
  • income vs. growth, and
  • diversification.

She will need to guard her $300,000 nest egg carefully. It's going to be harder for her to accumulate wealth after divorce.

That brings us to the first concept: Risk vs. Reward. She needs to be aware of the additional risks that she takes to get a high return on her money.

For instance, she can get about 6.3% on a 5 year CD. That would provide her a guarantee of principal and an annual return of $18,900. Or she could invest in the stock market looking for higher rates. But, then her money is at risk.

A prudent strategy would be to put part of the money in something very safe (like CD's) and part of it in something more aggressive (a mutual fund invested in stocks).

Starting Over will also need to choose between income and growth. With some investments she can choose to either take the money that's earned or have it reinvested.

The decision is an important one. She can use the income generated to help pay the monthly bills. But then the principal will never grow. And that's dangerous for the future. A 4% inflation rate will cut her buying power by half in 18 years.

By the time Starting Over is 83 the money will be worth only one quarter of its value today. But, she also needs to pay her monthly bills. You see the trade-off.

Every dollar that she spends today means three or four dollars that she won't have later.

Next, Starting Over needs to take advantage of diversification. That's the strategy of owning a variety of investments. Not only a number of different stocks, but different types of investments.

The reason is simple. Events that are bad for one type of investment will work to increase the value of others. Bad news for the stock market is often good news for bonds or real estate.

A good portfolio should include equities (stocks), debt instruments (bonds, CD's), hard assets (gold, real estate) and cash equivalents (money market funds). No-load mutual funds are an excellent way to participate in each.

Diversification is great insurance for the average investor. Starting Over should try to have about ten different investments. Each should be about 10% of her investable money. That way even if one loses money it won't impoverish her.

Finally, a comment to anyone who's thinking of going down this path. Your marriage may be hurting you emotionally today, but a divorce could add financial pain later.

The plain fact is that divorce is expensive. Not only the lawyers and advisors, but you can't run two households for the price of one. The only way to hold expenses is to reduce lifestyle. So please think carefully before you head for divorce.

It's possible that the money and energy you'll spend on a divorce could be used to rejuvenate your marriage. We wish all the best to Starting Over and her family.

�2000 by Gary Foreman. All rights reserved.

Gary Foreman is a former purchasing manager who currently edits The Dollar Stretcher website and newsletters.

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