School, College and Other Living Expenses Can Create Stress Down the Road
Susan and Michael Johnson thought their divorce would be different.
When they decided to split after 15 years of marriage, the couple was determined to keep things amicable and to avoid the horror stories they’d heard so often from friends and relatives. Above all, they were committed to making sure their son David, 11, would be well cared for.
Working with their attorneys, the Johnsons reached a financial settlement each felt was fair. Michael had been the primary wage earner, bringing home $65,000 a year. He also had an $85,000 pension that he wanted to keep. Susan wanted to keep their house so that she and David would not have to be uprooted. Since the equity in the house was about $100,000, $15,000 more than the value of Michael’s pension, they decided that the fair thing would be for Michael to get $21,000 of their savings, with Susan keeping the remaining $6,000. This would balance the differences in value between the pension and the house.
Because Susan’s take-home pay was only $10,000 a year, Michael also agreed to pay her $800 a month in spousal support for five years, in addition to the $925 a month he was paying in child support until David turned 21. Michael also agreed to pay the costs of sending David to a four-year public college.
Now, three years later, things have gone very wrong for Susan. Though Michael has never missed a payment, Susan has no money in the bank and is having trouble making ends meet. The $6,000 in savings is gone. She is behind on her mortgage payments, and she is in real danger of losing the house. Suddenly, the settlement that seemed so fair three years ago doesn’t look like such a good deal, at least not for Susan and David.
This outcome is not unusual because people rarely have a good understanding of what they are agreeing to. Numerous studies of the economic consequences of divorce have shown that the standards of living of the two parties often diverge dramatically over time, often with disastrous consequences, despite attempts to ensure that the outcome would be as fair as possible. These drastic reductions in standard of living, and the stress they create, frequently take their most serious toll on the children.
While financial settlements attempt to address the needs of all parties, they are often agreed upon with limited insight into the long-term economic consequences. As a result, settlements that appear fair and workable on the surface do not always stand the test of time.
The good news is that what happened to Susan Johnson was predictable and avoidable. As shown in the following projections, Susan’s expenses would exceed her income, and her projected working capital would decrease to financial ground zero in approximately three years. While she would still have assets, they would be tied up in the house and only accessible at great cost. If she waited too long to rectify this problem, her net worth would continue to decrease, and her worst fear would be realized, she would lose the house. Furthermore, because she had exchanged any rights she might have had to Michael’s pension, she would be faced with the prospect of winding up with neither.
Although with professional help it’s probably not too late for our hypothetical Susan to find her way out of her current financial predicament, she will have fewer options and will more than likely be forced to make financial compromises she would not have had to consider three years earlier. Had she analyzed the long-term economic consequences of alternative settlement scenarios, prior to reaching her agreement, she may have been able to arrive at something more workable, and she might not be faced with this potentially devastating problem.
Are you considering a particular settlement scenario? Are you sure it will work for you? Do you know what you will need to do to make it work? Are there potential problems that you need to be aware of before you sign on the dotted line? Would other settlement scenarios work better for you? It’s worth consulting with a professional to help you best determine the answers to these questions.
About the author: Carl M. Palatnik is a Certified Financial Planner practitioner, a Certified Divorce Financial Analyst and an Accredited Asset Management Specialist.
