Undoubtedly, for the client the postdivorce budget becomes a key issue. The reason is obvious. Following a divorce, typically cash flows are reduced and access to credit becomes restricted. Then, through a thoughtful analysis the planner can determine if the former lifestyle is still sustainable. Regardless of the findings, in collaboration with the clients, at this stage the planner’s objec- tive is to establish an informed spending plan.
Create Personal Financial Statements
In the cash and debt management analysis a logical starting point is to con- struct the postdivorce financial statements. The statement of net worth, or the balance sheet, provides a snapshot of assets and liabilities. The statement of cash flows, or the income statement, provides a projection of income and expenses for the single client. In building these statements, both of which were discussed in Chapter 6 in detail, it is recommended that the planner document the details (preferably in footnotes) that will help in analyzing the assets, liabili- ties, income, and expenses.
Assets. Assuming that during the settlement process there was an equitable dis- tribution of assets, it is reasonable to expect that the client’s net assets would now be substantially lower than what existed during the pre-divorce era. So it makes sense to ensure that the required distribution of assets did occur in accor- dance with the terms of the divorce decree.
The planner can begin by analyzing the state of short-term assets—money market accounts, bank savings accounts, and CDs—to ensure that they are properly titled. Here it is appropriate to ask, “Were jointly-owned bank accounts closed?” and “Were new accounts re-opened in the client’s own name?” If any of the accounts are established as a “payment on death” account or as a “Totten trust,” then verify that the correct beneficiary is named in these accounts. If cash value life insurance is listed among the assets, ensure that the policy recognizes the appropriate owner and the beneficiary.
Next, the attention can be diverted to long-term assets. These include: qualified pension or employer retirement assets, individual retirement assets, the resi- dence, a second home, automobiles, boats, collectibles, and other personal assets. For these, it is critical that each asset carries the appropriate title. For example, an automobile that was previously registered under both names would now need to be re-registered under the client’s name with the depart- ment of motor vehicles.
Debt (Post divorce). An important outcome of divorce proceedings relates to the allocation of debt. It is risky for the client to remain liable for the ongoing debts of the ex-spouse, since that would hurt the client’s credit ratings. Consequently, if the planner discovers that any of the outstanding pre-divorce, jointly-owned, debts are still in place. Ensuring that the problem is resolved should become the planner’s top priority. Appropriate actions might include: (a) closing existing credit card accounts in the names of both spouses and opening a new credit card
account only in the name of the client; (b) canceling debit cards in jointly- owned accounts; and (c) changing outstanding consumer loans (such as auto loans) for which both parties are liable.
The existing home mortgage can also present a challenge. How? Say, if at the time of settlement, the client signed a quit claim deed. While the quit claim deed transfers ownership of the home, it does not remove the person from the mortgage liability. So, by remaining on the existing home mortgage, the client would not only have difficulty qualifying for a new home loan, but would also be hurt by a negative credit rating. A possible solution is to initiate a plan to refinance the home mortgage.
Remember, since credit reports play such a pivotal role in our financial system, the planner should analyze the credit reports, paying attention to the changes in these reports following the divorce. If there are activities that negatively impacted the credit reports, and these activities can be linked to the former spouse, steps should be taken to ensure that the client’s credit is protected from the negative impact of these activities.
Analyzing Cash Flows
A major task of the financial planner is to focus on the client’s new cash flow situation.
By definition, the client’s income sources will materially change. Maintenance (alimony) and child support payments, most of the time, will become a major source of cash flow. Simultaneously, expenses will significantly increase as new and revised needs surface (such as, child care costs, insurance premiums, and alimony payments). So in order to develop a new cash management plan, the planner must collect data, identify reasonable and supportable assumptions, project future cash inflows and outflows, and synthesize the data in order to formulate the final recommendations.
Cash Flow Implications of Staying in Family Home. Often one of the divorcing spouses receives the family home as part of the divorce settlement. There are memories and comforts associated with that living arrangement. If the client is awarded the home, the planner should assess the new situation to make sure that the new cash flow situation is sufficient to maintain the house. Why is this so important? Now it will be the sole responsibility of the client to pay for the mortgage plus all the operating costs, handling the house upkeep, and the repairs. Since these are tall orders, the planner will have the responsibility for
explaining to the client the financial implications of remaining in the home and, if conditions so warrant, recommending selling the asset and moving to a lower- cost alternative.
Alimony and Childcare Support. Alimony is a series of payments between former spouses, based on the concept of equitable distribution. In order to be tax deductible for the payor spouse, under a court decree or written agreement, these payments must be made in cash to the recipient spouse (or to a third party for the benefit of the recipient spouse) until death of either spouse, or remarriage of the recipient spouse.
Child support is a series of nondeductible contributions from the noncustodial parent to the parent with custody. Federal law provides that support payments be withheld from earnings when the obligated parent fails to fulfill the obliga- tion. Incidentally, it is important for the custodial parent to document costs associated with raising the children to demonstrate that the child support is being used for the benefit of the children and not for the ex-spouse.
One of the issues that can complicate the task of projecting future cash flows after divorce is that the client may not receive the alimony and child support payments that were an integral part of the divorce settlement. The situation is complicated if there is no collateral supporting the alimony and child support promise but there are indications that the commitment to provide alimony and child support might not be honored. These factors should be considered in developing reasonable assumptions for generating cash flow projections.
Emergency Fund. The total amount of available cash reserves is an important element of any cash management plan. It is critical for the single parent. Because of the single status, the custodial parent should try and accumulate cash reserves equivalent to at least six months of living expenses. While this might constitute a challenging target, given its critical nature, it is important for every single parent to set this as a desired target.