How to Keep a Divorce From Wrecking Your Finances
Craft a settlement the way an economist would
Divorce is always sad, but when it turns ugly, it’s terrible. You may remember The War of the Roses, the dark comedy where Kathleen Turner and Michael Douglas start out as a perfect couple and end up destroying their possessions — including their luxurious house and cars — because they can’t agree on who gets what. That movie is unfortunately hitting home for plenty of boomers and Gen X’ers. According to a recent survey by Allianz Life Insurance, two thirds of divorced women feel their divorce created a financial crisis.
Many of my friends have gone to divorce war, but unlike Turner and Douglas, they destroyed their finances (by paying steep legal fees), not their possessions. Divorce doesn’t have to be as financially painful as it so often is, though.
Why Divorce Turns Into War
What drives divorce wars? My hunch is that many are driven by very different assessments by spouses of the impact of their proposed settlements. For example, a husband may think his settlement proposal is incredibly generous while his wife thinks it’s miserably cheap. Without a neutral measurement stick, their fight — with the lawyers' meters running — can go on and on.
As an economist, I’d say that this is where economics can help couples. Its math and computer algorithms can figure out precisely how much each spouse will get to spend now and in the future under any given divorce settlement. And this analysis can take into account all relevant factors, including the division of assets, alimony and child support, child custody and the disposition of the marital home.
How do I know? My company recently released a software tool designed to limit divorce wars (full disclosure: I derive no income from my company). It calculates each spouse’s living standard under any proposed divorce settlement.
John and Sally's Equitable Divorce
Let me illustrate this new technology:
Take John and Sally Doe, both 50, who are untying the knot after 25 years. John earns $200,000; Sally earns $40,000. John and his employer both contribute $6,000 a year to his 401(k). Sally and her employer both contribute $3,000 to hers. John and Sally plan to retire at 65. The couple has one child, Sam, 10. Sam will spend 80 percent of his time with Sally and 20 percent with John. John will cover Sam’s college expenses. The couple own a $450,000 house with a $90,000 mortgage. John proposes that Sally live in their house for eight years, while he picks up three-quarters of the housing cost. Meanwhile, John will buy a condo for $200,000. Sally will buy the same-priced condo when they sell their house, sharing the proceeds 50/50. John also proposes dividing the couple’s $200,000 in regular assets and $1 million in retirement assets in proportion to their labor earnings.
John wants to be fair. He figures that paying for most of Sally’s and Sam’s housing for the next eight years, covering Sam’s college expenses and housing and feeding Sam one-fifth of the time is highly generous. He also believes his and Sally’s living standards will be pretty similar once his much higher tax payments are factored in. So John proposes no alimony or child support.
Is John right? Will he and Sally be able to spend roughly the same amount over the rest of their days?
No, he's wrong. But by playing around with the numbers and the software they can arrive at an agreement that works for both of them.
John’s proposed settlement lets him spend $83,215 annually and Sally spend $23,353 annually (measured in today's dollars) after covering all housing costs and taxes. There are lots of reasons for this big differential, including John’s higher salary, his large asset share and his receipt of higher Social Security benefits.
When Sally points out the large spending (living standard) difference, John offers to split all assets 50/50. Now John’s and Sally’s annual spending amounts become $73,891 and $35,757, respectively.
Sally, who sacrificed her career to put John through law school and raise Sam, digs in her heels. “John, you need to pay alimony and child support,” she says. John agrees to $25,000-a-year in child support until Sam goes to college. Sally runs the computer program again and finds that John’s annual spending would now be $68,783 and hers would be $41,158.
Sally says, “John, sorry, but you wouldn’t be making five times my salary if it weren’t for me. There is no reason I should have a lower living standard going forward. If you pay me $20,555 each year in alimony and agree to the other things you offered, we’ll both get to spend the same amount each year: $54,836.”
John thinks this over and then counters with a $10,000 annual alimony payment, pointing out that his job is far more demanding than Sally’s. Sally, upon reflection, decides this is reasonable and the two hire a single attorney for one hour to draw up the agreement. Sally and John used economics to save their divorce.
How to Divorce Fairly
Couples don’t have to use our software to come up with equitable divorce agreements. You can also get a rough handle on your relative spending levels by comparing each spouse’s disposable lifetime resources.
To arrive at this number, you'd start by calculating your lifetime resources (the present value (how much a future sum of money is worth today) of your future labor, Social Security and other income including alimony and child support plus your current net worth. Next, you'd subtract the present value of your projected taxes, housing costs, expenditures on children and other expenses including alimony and child support payments. The difference is your spendable resources.
Do this for your spouse, too, and then divide by each spouse's maximum remaining lifespan. This is a rough calculation primarily because you'll need to guesstimate your taxes and may misestimate your Social Security benefits, since they may be different in the future than what you expect today.
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- Why Couples Divorce After Decades of Marriage
- Is It Time for a National Divorce Law?