Three fundamental questions relate to the division of marital property and debt.
(a) What property and debts are subject to equitable distribution? (b) What is
9 The New Jersey Family Law, 2nd ed., Chapter 9, Equitable Distribution Statue, Section 9.3. Irvine, CA: Michie Publishing, ISBN: 9781422475638. Retrieved from http://www.bookstore.lexis.com/
bstore/sample/michie/0327005750.pdf (accessed on 27 May 2016).
the value of the marital property? (c) What is a fair allocation of marital property and debts?
Generally, property acquired during the marriage constitutes “marital property.”
Obviously that can include many items, including: earnings, interest and divi- dends, financial securities (taxable and retirement assets), home, second homes or rental property, appreciation of property brought into the marriage, business appreciation, cash value of life insurance policies, collectibles, antiques, jewelry, and personal property (e.g., cars, boats). There is virtually no limit to what items flow into the marital property bucket. Three categories generally excluded from marital assets are: assets brought into the marriage, assets inherited during the marriage, and gifts received by either spouse during the marriage. Appreciation and income from those premarital assets and inheritances or gifts are usually considered marital assets, although one needs to consult state property- division laws.
Property Valuation
The valuation of marital assets ranges from simple to complex. For example, the value of an investment account that was opened during marriage and funded with joint earnings is the fair market value of the account. If an account was seeded from the premarital assets of one spouse and titled in his or her separate name, then the value for purposes of marital division might be just the appreci- ation of the account, not the fair market value.
However, if the home was purchased prior to the marriage and retained as sep- arate property of that spouse, then the marital value is typically the apprecia- tion in equity since the date of marriage. However, if the original owner of the home put the husband’s or wife’s name on the deed, then a “presumptive gift”
was made. The total equity is a marital asset.
Business valuation is complex, and a valuation expert should be consulted.
Ongoing businesses are valued using a variety of methodologies, including:
(a) market multiples (i.e., capitalization), (b) discounting of projected free cash flows, (c) valuation of intangibles (e.g., goodwill), and (d) application of allowable IRS discounts (e.g., lack of marketability, minority discounts). Similar to the home appreciate example, the nonworking spouse would typically be entitled to share in the business appreciation over the period of marriage; any value attributed to the pre-marriage period would not generally be considered a marital asset.
Other items that offer an element of valuation complexity are illiquid assets, stock options, antiques, and collectibles.
Division of Property
The concept of equitable distribution does not mean a 50/50 split. Let us walk through an example to clarify. Marsha and Andrew were married for 30 years.
She remained at home as the primary family care giver for three children.
Andrew focused on growing his company. Currently he earns $180,000 annu- ally. The company has a profitable title with a diversified customer base, and he expects the company to generate an ongoing income stream through retire- ment. His profit sharing plan is valued at $300,000. The family assets include a
$20,000 checking account, joint investment assets of $250,000, and home equity of $350,000. The business is currently valued at $500,000.
Assuming a 50/50 marital property split of the $1,420,000, each person would receive $710,000 after the sale of the family home. However, splitting the prop- erty and assets in equal halves might not be equitable, considering the needs and desires of each spouse and the economic circumstances. The following split may be more equitable, since it accommodates Marsha’s wish to remain in the home:
Total Marsha Andrew
Home $350,000 $350,000
Savings 20,000 20,000
Investments 250,000 250,000
Profit Shr. 300,000 150,000 $150,000
Business 500,000 500,000
Total $1,420,000 $770,000 $650,000
If this division of assets is accepted, Marsha would receive $770,000 and Andrew would receive $650,000. If a 50/50 property split is desired, then Marsha would still owe Andrew $120,000. This could be remedied with a property settlement note. In this interest-bearing note arrangement, Marsha would repay the amount due plus a reasonable rate of interest at some point.
Based on only a cursory look, it might appear that Marsha is the “winner” in this negotiation. However, after reflecting on long-term financial projections, that is probably not the case. Andrew retained the income-producing asset, and he possesses the job skills and contacts. Marsha is less likely to get a high- paying job. Moreover, her most valuable asset is the family home, which is illiquid. This settlement may put Marsha at real risk. Clearly her divorce lawyers will need to address the ongoing alimony payments.
The process of property division is a negotiation. Typically, both sides go back and forth in the negotiations. The judge is there to mediate fairness in case of a contested confrontation.
Personal Residence
One of the biggest financial issues that needs to be resolved in many divorce settlements relates to which spouse gets the family home. While the custodial parent is often the eventual recipient, that is not always the case. Many factors come into the settlement decision, including what is “fair and equitable” and what is financially viable. Clearly the costs of maintaining the family home might not be a reasonable for one parent following the divorce; cash flows might not be there to support the illiquid asset. Three common outcomes concerning divi- sion of the personal residence are: (a) one spouse buys out the other spouse’s interest in the property, (b) sell the home and divide the profits, and (c) own the house in some joint- ownership arrangements.
Buying out the other spouse’s interest offers a “clean break.” The amount of the buy-out is generally equal to one-half of the equity in the home, although there might be differences of opinion regarding the current fair market value. Other issues that might flow into the negotiation relates to capital gain taxes and broker commissions saved.
Selling the home and dividing the cash receipts, after paying off the remaining mortgage and broker commissions is another strategy for severing the relation- ship. Current tax law allows each spouse to shelter up to $250,000 of capital gains. Issues related to this course may include finding a new home or rental property, qualifying for a new loan, and dealing with the possibility that the children will have to attend a new school.
As opposed to a break, the two adults could continue to own the property jointly. This strategy has been popular in a recent down real estate market. The joint-ownership might be for an indefinite period or for a defined period (e.g., until real estate market recovers, remarriage of spouse living in the home, etc.).
If this settlement option is selected, it is recommended that home maintenance, mortgage payments, and tax-liability responsibilities are clarified in writing.
Retirement Assets
Qualified retirement and other tax-advantaged retirement plans (e.g., SEP, SIMPLE, 403b, 457, IRAs) accumulated and vested during the marriage are
considered marital property. Often the personal residence and the retirement accounts are the largest financial assets to be divided.
The division of retirement assets can either be on an “immediate offset or pay- ment” method or a “deferred distribution” basis.10 An immediate division would divide current of the alternate payee or transferred to a tax-deferred account that is owned by the divorced spouse. A deferred benefit approach shifts the equita- ble division to a percentage of retirement assets; this percentage of distributed assets is paid to the alternate payee by the plan administrator during retirement.
As mentioned in Section I, the QDRO establishes the marital property rights of the divorce spouse. The court order allows for distributions from a quali- fied plan to an alternate payee and describes how deferred retirement ben- efits are to be assigned. The court defines what fraction of the accrued annual benefit from a defined contribution plan needs to be paid to the alternate payee. The future retirement benefit from a “defined benefit plan”
is more involved and requires the services of an actuary.11 Note that a QDRO is not needed to divide IRA, SEP or SIMPLE assets; however, the division must be part of the divorce decree and rolled over to an IRA opened by the recipient spouse.
Career Assets
Career assets for the employed spouse include: employee benefits (e.g., health and disability insurance, vacation days, group life), vested retirement assets, stock options, professional networks, job skills, and education. Retirement assets and stock options are marital properties and subject to division. However, as a general rule, future earning power (career enhancement, professional degrees) is generally considered when determining maintenance and equitable division of marital assets. If education was supported by the other spouse, then the expense of the education may be awarded during the divorce settlement.12 Again, the planner should check the state divorce law.
10 See note 9, section 9.22.
11 David Parker, 2014, “Qualified Domestic Relations Order”. Retrieved from http://retireontime.
net/uploads/images/articles/QDRO.pdf (accessed on 27 May, 2016).
12 “Property Division in Divorce,” Lawyers.com. Retrieved from LexisNexis http://family-law.law- yers.com/divorce/Property-Division-in-Divorce-Degrees-and-Licenses.html (accessed on 27 May, 2016).
If there is a family-owned business, then that is a marital asset. Similar to the division of the personal residence, the division of the business could be resolved by: (a) one spouse buying out the other’s spouse’s interest in the business, (b) selling the business and dividing the profits, or (c) continuing to own the business in a joint-ownership arrangement.
Allocation of Debt
Debt acquired during the marriage generally constitutes “marital debt.” This debt might include: home mortgage, home equity loan, second-home mortgage, auto loans, student loans, business loans, credit card debt, and loans against cash value life insurance or qualified retirement plans. Just as marital assets are divided between the divorcing adults, so are the liabilities. Note that debt brought into the marriage is not generally considered marital debt, although the planner will need to consult property-division laws within the state of residence.
Consistent with the idea of equitable distribution, debt is not necessarily divided 50/50 between the divorcing spouses. Numerous factors are considered. These include who initiated the debt, who benefited most from the debt and who has the greatest ability to repay the debt.