You Can Lead A Horse To Water
View the original Divorce Financial Analyst Journal article by Wendy Hayes here.
State of Affairs
Wren and Donald have been married for 12 years and have two children. Wren would really like a divorce. Donald does not. Wren is not sure that she can afford to be on her own. She has indicated that if she decides to divorce that they would have 50/50 custody of their children and that she would like them all to live in close proximity. Wren wants this to be an amicable process for the couple and hopes that they can remain friends.
To date, Wren has been able to pursue her passion which pays very little. Wren is currently looking for a full-time job and anticipates that she will make approximately $50,000 per year starting out.
Donald is an executive and has a base salary of $225,000 plus bonus potential as well as stock options. Donald also received a signing bonus from his current employer in the form of a forgivable loan which will vest over 4 years. A large part of Donald’s compensation at his last company was in the form of Non-Qualified Class A Stock Options. Donald was granted 17,500 shares that were to vest at 20% per year for five years. Donald was able to exercise 7,000 shares for $5.50 per share while still employed. The shares were purchased by the company at $100.74 per share. When Donald left the company, his separation agreement stated that the remaining 10,500 shares would be purchased by the company as they vest for $100.74 per share. Considering the exercise cost of $5.50, the net benefit will be $1,000,020. The options are not transferable. If Donald dies prior to the stocks being exercised, Donald’s heirs can exercise the shares.
The couple has cash and investments of approximately $450,000. This includes the $100,000 signing bonus/forgivable loan.
The couple has retirement assets of approximately $200,000.
The marital home has approximately $600,000 in equity and a mortgage balance of $350,000. Wren would like to stay in the marital home.
The couple has approximately $20,000 in debt. However, the forgivable loan, technically is an asset with a corresponding liability that will either be forgiven over Donald’s employment with the company or perhaps paid by a new employer if Donald makes another career move.
Wren’s Potential Outcome
From an asset and liability perspective, Wren’s outcome is good. She should receive approximately $1,150,000 in assets less liabilities. Wren will also receive child support and should receive alimony for some period of time. Calculating Donald’s income is a bit complicated as he has only been at his new company for a few months. In reviewing past tax returns, Donald has consistently made $350,000 for the last 4 years. This is the number that was used to calculate child support and alimony.
There are concerns about standard of living and expenses. The marital home is a large older home that has been remodeled, but is still expensive to maintain. The children’s expenses are also very high.
The recommendation is made that Wren consider allowing Donald to remain in the marital home and for her to look for something that she will be able to more comfortably afford on her anticipated salary understanding that alimony will only be for a few years and child support will go away in 10 years.
Feeling confident that she could make it on her own, Wren told Donald that she wanted a divorce. Wren did decide to allow Donald to stay in the marital home. However, Wren purchased a new home, before a settlement was reached, that will result in monthly payments of over $3,000 per month. In order to secure a loan, Wren was able to get her father and step-mother to co-sign the loan. On an expected $50,000 salary, this is not the best decision.
Wren also indicated that Donald was not comfortable with child support and alimony being calculated on $350,000. Donald wanted credit for paying many of the children’s expenses directly. The child support and alimony were recalculated using Donald’s base salary with Donald paying the children’s tuition, insurance, and extra-curricular expenses directly.
Donald did not want the non-qualified stock options included on the marital balance sheet and Wren was content to agree with that. Since this asset represented almost half of Wren’s settlement, it was of grave concern. The company had a history of paying the stock options and so a value was easily calculated. In addition, Donald’s separation agreement specifically stated that the company would purchase the options. Wren was strongly encouraged to seek the advice of a lawyer who specializes in Employee Benefits relative to divorce and she has declined. It is not known if Wren’s interest will be protected when the stock options are paid to Donald. One way to protect Wren would be to note in the Settlement Agreement that Donald must provide Wren with tax returns and substantiating W-2’s and 1099’s until all options are repurchased by the company. Because Donald would pay Wren for her half of the options net of taxes, this would allow her to see what that tax liability was. Another option would be to have Donald execute a promissory note for Wren’s share of the options that would be payable based on the vesting schedule net of taxes. The promissory note could be secured by a lien against Donald’s home (the former marital home) to ensure payment is made. In addition, it would be important to ensure that if Donald dies prior to the options being repurchased that Wren would inherit half of the stocks and be free to exercise them. To be fair to both sides, there could be protection for Donald. The balance of the promissory note would be null and void if the company become financially insolvent.
Because Donald was going to be staying in the marital home, it was agreed that as part of the settlement that he would owe Wren $200,000. He was comfortable taking $100,000 from a home equity line of credit that would be in Donald’s name only. Donald wanted to pay the balance after his alimony obligation ended. It was suggested that a Promissory Note be executed and Wren secure this Note with a lien against the marital home and she declined.
This case had a disappointing outcome in several ways. In helping clients to understand their financial situations, we want to ensure their equitable settlement and set them up for future success. In Wren’s case, despite advice to the contrary, she made decisions that put her financial future in jeopardy. From a financial perspective, Wren is leaving a very comfortable and secure situation. Wren believes that Donald will be amenable to partnering with her going forward for the sake of their children and their friendship. That may be the case. However, it is our role to hope for the best and plan for the worst. The concern is that as the dynamics of their relationship change and the new reality sets in that:
- Wren will struggle to make ends meet
- Donald may not pay Wren what she is owed on the stock options and Wren will have no way of knowing when they are paid to Donald
- Donald may not pay Wren the balance of the amount he owes her for the equity in the marital home
Wren certainly has the option of pursuing legal recourse if problems ensue. Legal actions are costly and emotionally draining. Potential future problems can often be avoided if addressed more adequately in the Settlement Agreement. We can lead a horse to water, but we cannot make them drink. Ultimately, the decisions are the clients, but it is important in situations like this that you document and communicate your concerns.
Case Study: Betty and Dan's Alimony Story
Betty and Dan had been married for thirty years when they divorced in 2008. Dan had enjoyed a lucrative career in a niche market. When the financial crisis of 2008 struck, Dan was no longer able to earn the same type of money that he had previously.
When the divorce was granted in 2008, Betty was awarded alimony of $5,000 per month based on the income the couple had had for the last couple of years. When the economy imploded, Dan was not able to pay his bills or Betty’s alimony. Betty was dependent on the alimony to maintain her lifestyle and refused to believe that Dan was no longer able to earn the same type of income. Dan was desperately trying to find new ways to make money and accept that the career he had enjoyed may never recover from the economic collapse of 2008.
In 2015, Betty sued Dan for unpaid alimony and an increase in future payments. Dan countersued for reduced future payments and an realistic repayment schedule. Dan’s attorney contracted Mitchell Hayes to analyze the situation and help present to the court a more realistic solution.
The analysis revealed that the couple’s best two financial years were the two years immediately preceding their divorce. The analysis also revealed that based on the debt that Dan incurred post-divorce for living expenses and alimony payments that it was unlikely Dan would ever be out of debt.
Mitchell Hayes prepared a report that provided a comprehensive view of the couples income and expenses for the 5 years pre and post-divorce. This report highlighted that the amount of alimony originally awarded was exceedingly high and that Dan was no longer able to make the same type of income he had previously. In addition, based on Dan’s debt and ongoing expenses, Dan did not have the ability to pay the alimony awarded in the divorce. Betty also admitted during her testimony that she was able to work, but chose not to.
The judge reduced the ongoing alimony payments to $1,000 per month and ordered the arrears to be paid back at $500 per month.
John & Jane’s Story
John and Jane are 40 years old and have two children. They own a home worth $165,000 with a net equity of $77,500. Their retirement savings total $165,500. John earns $90,000 a year and has a take-home pay of $68,760 a year. Jane has never worked outside the home and has no job skills, but hopes to get a part-time job with take-home pay of $8,900 a year.
The following settlement has been suggested. After the divorce, Jane and the children will live in the matrimonial home, which will be deeded to her. She will also receive $44,000 of the retirement savings while John will receive the remaining $121,500, thus dividing the assets equally. John will pay Jane spousal support of $600 per month for five years and child support of $225 per month per child. He will also pay the children’s college costs, starting in four years.
John’s expenses include his normal living expenses, child support, spousal support and education costs. Jane’s expenses include support for the children, and will be reduced as each child leaves home to attend college.
At first glance, this appears to be a reasonably fair settlement. However, a detailed analysis creates the financial future illustrated in Graph 1 (below). As you can see, Jane’s assets will be completely depleted within seven years, whereas John’s investments will grow dramatically.
To improve Jane’s financial future, an alternative settlement could provide her with increased spousal support of $1,500 per month for 10 years – which would actually cost John $1,005 per month in after-tax dollars.The correct child support for two children according to the Child Support Guidelines in their area is $1,136 per month for a payor with John’s income. Jane could also be awarded an additional $24,300 from the retirement savings plans, although she might need to cut her expenses by 10%. These changes in the original settlement would produce the results illustrated in Graph 2 (below). If they are made, John will still have a surplus, which he can add to his investments. If John stays within his budget and invests all of his extra income, his investments have the capacity to grow to $2.5 million by the time he is 60.
This example illustrates the value of financial planning as a means of reaching a more equitable divorce settlement. If the court’s intent is to treat both parties in a divorce as equitably as possible, it is essential to analyze the marriage as if it were a financial contract, and a CDFA™ is uniquely suited to do so.
Wendy Hayes is a highly creative, accomplished accounting and finance professional who has leveraged her own experiences with life transitions to launch Mitchell Hayes. Learn more about what drives Wendy.