Suze Orman's Post-Divorce Guide to Personal Finance
May 23, 2011
O's money expert helps one mom get real about her financial situation—and shows her how to make her future a secure and happy one.
At 52, Diana Thomas* finds herself at a major crossroads. As she and her husband work out the final details of their divorce after 23 years of marriage, Diana must now become the chief financial officer of her new life, and that of her 11-year-old daughter, Mary, for whom she'll assume a greater share of living expenses. That's a big step, and Diana has been anxious. In fact, she e-mailed O at 3 in the morning recently, asking me to help her sort through it all. She told me she sensed things weren't going to add up financially, but that she was ready to take on whatever changes were necessary. "I want to know the truth," Diana told me. "I need a reality check."
Right then I knew she was ready to make the transition to her new life. When you have the strength and determination to face the facts, you can achieve anything. It's when we run and hide that we dig ourselves holes that can be excruciating to climb out of. Embrace the truth, and you'll have what it takes to move forward into a better life. Diana didn't realize it just yet, but she was already well on her way.
An information analyst for a city in Southern California, Diana has a natural talent for sizing up situations and developing game plans. But for anyone facing a major change, one of the hardest steps is recognizing that what worked in the past may not be feasible today.
As part of her pending divorce agreement, Diana will assume full ownership of her three-bedroom, two-and-a-half-bath home, seven blocks from the beach. She and her husband bought the property in 1996 for $355,000, and similar homes in the neighborhood have recently sold for about $950,000. Diana decided she would rather receive the home and its equity in the divorce settlement than 11 years of spousal support. Keeping the home would lessen the impact on her daughter, Diana felt, and would allow her to tap some of the equity to get ahead of a few financial challenges. For starters, she has $7,000 in high-interest credit card debt, and a leak from her deck that will cost $25,000 to repair—neither of which she can comfortably cover with the $11,000 in her savings account. Diana was also planning to use some equity to pay for Mary's college, as well as to supplement her own retirement savings.
I understood her desire to stay put after the emotional upheaval of the separation. But I told Diana that using her home as a savings account would lead to trouble; she would just keep tapping and tapping until she was tapped out. After I pored over the financial information Diana sent me, it was clear that she simply can't afford to keep the house. Diana's gross monthly salary is $6,667. After she pays taxes and sets aside 10 percent for retirement, her take-home pay is about $4,000. She will also receive $1,400 a month in child support for the next seven years. That combined $5,400 a month still leaves her $3,000 short of the amount she needs to cover expenses, the largest of which are her mortgage, property tax, insurance, and utilities (totaling about $3,000), and $1,800 for Mary's private school tuition. The life that was affordable when Diana also had her husband's $150,000 income isn't any longer.
Diana took this information in stride, and right away we discussed what relocation might look like. Diana told me she could rent a two-bedroom apartment nearby for $2,000 or so; that would be at least $1,000 less than her current total monthly housing costs. Then we considered what she might net if she were to sell the home. Because of the sizable capital gain, she will owe some tax if she sells as a single homeowner. (For married couples, the first $500,000 in capital gains is exempt from federal taxation; however, the exemption is only $250,000 for singles.) After paying the agent and eliminating the $7,000 credit card debt, Diana could have as much as $600,000. If she invests that in solid municipal bonds, she could earn 4 percent in tax-free income; that $24,000 a year would cover her $2,000 monthly rent, leaving her entire $4,000 in take-home pay and $1,400 in child support for expenses.
I was glad Diana was open to selling the home, but when I asked her how Mary might feel about the move, there was a long pause. I suggested that Diana present Mary with two options: Downsize to a smaller place and stay in private school, or keep the house and transfer to public school. Diana is the ultimate decision maker here, but acknowledging Mary's wishes is an act of love and respect in this difficult time.
The third option to consider is the most difficult one: Sell the home and have Mary transfer to public school. That would allow Diana to aggressively save for retirement, and for when she no longer receives child support. Many divorcees neglect to plan for the day the spousal or child support will end. When it does, they're often in big trouble.
*All names have been changed.
Putting Herself First
Diana hopes to retire at 65—just 13 short years from now. If she's going to hit that mark, she must make retirement security her top priority. Which is why, when Diana asked how to save for Mary's college, I told her not to. There are loans for college but none for retirement. I said it was time to stop putting her daughter's needs ahead of her own. "I did that with my husband, too," Diana said. "I do it with everyone."
After she retires, Diana will receive a public pension that will pay her about $4,000 a month after taxes. And if she continues to save through her 457 plan—the government equivalent of a 401(k)—she could have more than $500,000 by the time she's 65. That's an impressive sum, from which Diana can safely draw about $1,700 a month once she retires. Because she was married for at least ten years, Diana will also qualify for a Social Security benefit equal to half her ex-husband's, giving her another $1,000 or more each month. (As a public employee, Diana does not pay into Social Security.) She also told me she hopes to relocate to a less expensive area once Mary leaves for college. If Diana keeps the $600,000 from the home sale, she can likely buy a home outright.
Diana is pondering her options. Now that she has all the facts, I'm confident she'll make the right choices once her divorce is finalized this fall. The only step that I insisted she take right now is to clarify in her divorce decree how her husband's life insurance benefit would be passed to Mary. If something were to happen to him, his life insurance policy would provide support for their daughter. Diana and her husband have already agreed that he must maintain his policy, but I was concerned when Diana told me that Mary would be named as the beneficiary. That's a big mistake. Minors aren't allowed to receive insurance payouts directly, so when a parent dies and a child is the beneficiary, the courts get involved—meaning there may be a huge legal hassle before a penny is disbursed.
What needs to be spelled out in the divorce settlement is that Diana's husband will set up a revocable living trust, and make that trust the beneficiary of the life insurance policy. The trust should stipulate that if the death benefit is paid out while Mary is still a minor, Diana—or someone else the parents mutually agree upon—will be the trustee of those funds.
A Fresh Start
There is no question that divorce is a challenging process. But Diana seems to intuit that she can help herself and her daughter begin their new lives by making smart choices for their future. Throughout our conversation, Diana was eagerly taking in my advice, not cowering in fear or defensiveness. Afterward, I asked her how she felt about everything I'd said. "It's great to know all of this," she said. "I was just spinning my wheels, ruminating. The truth really does set you free." Amen to that.