A Price Tag on Emotions: Divorce Math
Bob and Sally arrive for their first appointment and announce, “We have everything worked out. This will be an easy mediation for you.”
What I know is that divorce mediation is never easy.
In this case, Bob and Sally have no children and have been married for 12 years. They may have less complicated circumstances, but it is never easy.
At some point there will be an emotional conversation concerning a financial asset. That’s when folks put a price tag on emotions. That’s when there is an underlying equation that translates into a financial request.
Put All the Financial Cards on the Table
Being well-informed is a very important concept within mediation. It’s what keeps a mediated agreement durable and avoids future conflict.
The beauty of mediation is that clients get to make choices that work for them. The key to a successful mediation process is when everyone is well-informed. Then they make the emotional and financial trade-offs that work for them, and they will not have regrets in the future.
Come to Mediation Prepared With Financial Data
In a previous post, I talked about the homework I assign to divorce mediation clients. Gathering this financial information is key to the success of these discussions.
When Bob and Sally have worked out everything at their kitchen table, I respect their effort and ask them to be more specific. As they recite their conclusions, I map their information into the mediation process.
For clients without children, that results in a table similar to Table 1 below. The Item and Value columns show the Assets and Debts as they stand now, before splitting anything.
The Bob and Sally columns show the redistribution of assets as discussed in the paragraphs below, still done with a focus on a 50/50 split, though the bottom-line dollars don’t look that way:
Table 1-Assets and Debits
| Assets | Value | Bob After Decisions | Sally After Decisions |
|---|---|---|---|
| Net equity of house (*) | $40,000 | $40,000 | |
| Mutual funds | $10,000 | $5,000 | $5,000 |
| Bob's car | $15,000 | $15,000 | |
| Sally's car | $5,000 | $5,000 | |
| Subtotal | $70,000 | $20,000 | $50,000 |
| 401K-Bob | $70,000 | ||
| 403B-Sally | $30,000 | ||
| Sub-total retirement (#) | $100,000 | $78,000 (see discussion) | $22,000 (see discussion) |
| Teacher pension | TBD | (see discussion) | (see discussion) |
| Total assets | $170,000 | &98,000 | $72,000 |
| Debts | Value | Bob After Decisions | Sally After Decisions |
| Car loan-Bob | $5,000 | $5,000 | |
| Visa-Bob | $3,000 | $3,000 | |
| Visa-Sally | $2,000 | $2,000 | |
| Total debt | $10,000 | $8,000 | $2,000 |
| Net Assets | $160,000 | $90,000 | $70,000 |
| Asset adjustments | For cars | -$2,500 (see discussion) | +$2,500 (see discussion) |
| 50% Split | Desired: $80,000 | Actual: $87,500 | Actual $72,500 |
* Net equity=The fair market value of the house minus the mortgage minus refinance or selling costs.
# These numbers assume Sally will stay in the house and that she compensates Bob using her share of these retirement savings accounts.
The Decision About How to Share Money
It is important for my clients to understand they can share their assets and their debts in any way that feels fair and equitable to them. In fact, NYS is an “equitable” state, not an “equal” or “community property” state. That means clients get to choose how to share their property. (Please refer to the NYS Equitable Distribution Law for more information.)
What Bob and Sally need to understand is that every dollar is not equal when sharing funds.
Trading House Equity Dollars for Retirement Savings (IRA, 401K) in a Divorce
A very common client suggestion is to trade a retirement asset for the value of the house. Let’s first look at retirement savings such as IRAs, 401Ks, 403Bs, etc. Pensions are discussed in my post, “Anything But My Pension-Divorce Math.”
Let’s imagine that Sally would like to stay in the house that has a net equity value of $40,000. Using 50/50 as an equitable distribution guide, she would owe Bob $20,000 as his share. Sally suggests Bob keep $20,000 more of the total retirement savings ($100,000), and then they will be even.
Under this arrangement, Bob would keep his original 50% ($50,000) of the total retirement savings ($100,000) plus $20,000 out of Sally’s $50,000 of the total amount of retirement savings.
But here is how the math actually works: The retirement savings accounts are pre-tax, meaning income taxes will be due when the money is withdrawn from those accounts. There are no taxes on the equity of the house.
If Bob receives an extra $20,000 of retirement savings now, he will really net only $14,000 when he starts to withdraw the money. That is what is left after he pays about 30% in taxes, even in 15 or 20 years.
In order for Bob to fully benefit from the extra $20,000, he needs to be compensated now for the taxes he’ll have to pay later. Sally needs to give him $20,000 divided by .70 (using a 30% tax rate), which comes to $28,000 out of her share of the retirement savings.
Therefore, on the chart you can see that Bob shall retain $78,000 of the retirement savings, and Sally shall retain $22,000.
Divorce Math: Divide the Sum of the Assets by the Number of Assets
Another misapplied strategy is sharing assets or debt by subtracting one from the other.
Continuing to work with our couple, Bob’s car is worth $15,000, and he has $5,000 left on his loan. The net amount is $10,000. Sally’s car is worth $5,000.
Many clients would say that Bob should pay Sally $5,000 for the difference in the value of the cars, ignoring the loan amount on Bob’s car, which lessens its value.
Balancing Assets and Related Debts
Instead, subtract any debt directly related to each asset, add the value of the two assets together, and then divide by the number of assets, in this case, 2. This determines what each person “could” have so both receive the same value.
Here’s the math:
- 10,000 (value of Bob’s car after subtracting car loan) + 5,000 (value of Sally’s car) = $15,000.
- Divide by two= $7,500.
- If the couple decides each should have $7,500 worth of car, Bob owes Sally $2,500.
New Information Via Mediation Brings New Divorce Decisions
I often say to clients, “No matter what you decided at your kitchen table, if you learn something new here, you both get to make a different decision.”
As a mediator, I do not “stir the pot,” and I believe completely in the self-determination of my clients. I only ask that they make sure they are well-informed. I do not want my clients to have their agreements unravel when other resources “educate” them. I want them to be able to say, “I knew that, and this is what I want to do.”
Bob and Sally were pleased and grateful with the information they received and the mediation process itself. They understood the “divorce math” needed to achieve the distribution they desired, and they had increased confidence that it was fair and equitable in every way.
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