When my ex-wife and I divorced, sorting out the financial side was the biggest logistical headache that we had. Not wanting to deal with this overhead in the midst of the emotional challenges we were facing meant that we put off formalizing our divorce for a long time. Taking just two simple steps before tying the knot would have made our lives significantly easier.
The first step is to know the separation rules for your state as they pertain to finances. Notably, you may not have realized that everybody has a prenuptial agreement (a “prenup”). If you and your partner haven’t crafted your own, you get the state default version. There are two main schemes for dividing assets and liabilities between you and your spouse: community property and equitable distribution.
In a community property state, each spouse is entitled to half of the marital assets acquired during their marriage, and keeps their separate property that pre-dated the marriage. This halving covers almost any marital asset — it doesn’t matter who earned the money, who’s account it’s in, what it’s earmarked for, etc. There are nine community property states in the US — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In most of the remaining states, assets and earnings accumulated during marriage are divided equitably (fairly), but not necessarily equally. In some of those states, the judge may order one party to use separate property to make the settlement fair to both spouses.
It may be helpful to sit down with your spouse and create an agreement on what constitutes separate property and what you consider marital property, and what you believe is a fair way to allocate this in the event that your marriage doesn’t work out. You may want to think about things like:
- Retirement accounts that began before marriage
- Premarital real estate
- Post-marital real estate purchases funded in whole or in part with pre-marital assets
- Collectibles with significant value pre-marriage
- A business or professional practice launched before marriage
- Investment portfolios
- Stock options and restricted stock units (RSUs)
- Trusts
- Future inheritances
- Appreciation in value post-marriage of separate property
If the rules that seem fair to you as a couple do not sync up with the default that your state offers, it may be worth consulting an attorney about creating a prenup.
Of note is that the state that you’re residing in at the time of separation is typically the jurisdiction of interest, although this varies from state to state (e.g. New Hampshire has no residency requirement for filing for divorce, so anyone can get divorced there).
There are also typically strict rules to ensure the fairness of a prenup, and these rules can also vary from state to state. For an example, in California, each partner must engage their own attorney to review the prenup (or waive the right to do in writing), and must have at least 7 days to review the agreement prior to execution. Also, each party must fully disclose their assets and liabilities, or risk the prenup being voided in the future.
The second step is to segregate pre-marital and post-marital accounts. This means creating new checking, savings, retirement and investment accounts at the time of legal marriage. Any place where your post-marital income may be directed should be separated. Redirect any direct deposits and automated bill payments to these new accounts. Essentially, you want to prevent commingling of separate property and community property — especially avoiding any asset transfers from community property to a separate property account. Furthermore, only go the other way (from a separate property account to a community property account) if you’re comfortable with the transferred asset or amount becoming community property.
Why isn’t it enough to just know the balance of your accounts on date of marriage? Consider the case where you have 100K in a savings account before marriage, and then put another 100K in that same account after marriage. If you purchase a 100K Tesla after marriage and fund it from this savings account, did the money for that Tesla come from the pre-marital 100K or the post-marital 100K? In effect, is the Tesla separate property or community property? There’s no clear answer, so it may become a topic for divorce attorneys to dispute over. However, if you had avoided commingling pre-marital and post-marital assets in the same account, the issue would be more clear cut.
Once you’ve taken these two steps, what’s a good way of structuring postnuptial finances? I’ll cover that in the next post.