Divorce & Investments

by Rob Jennings J.D.
You'll have to separate your investments along with your personal lives when you divorce.

You'll have to separate your investments along with your personal lives when you divorce.

David De Lossy/Photodisc/Getty Images

Intertwined personal lives aren't the only things a divorcing couple has to separate when their marriage comes to an end. Unless you were married for a very short time, both you and your soon-to-be ex-spouse will probably have made investments -- whether in the form of stock trading accounts, mutual funds or retirement accounts at work. While splitting personal property can be as simple as signing titles, dividing the various investments you've made is both trickier and riskier.

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Property Division

State law on property division varies from jurisdiction to jurisdiction. In community property states, judges must divide your marital property and debt equally. In equitable distribution states, which make up the majority of jurisdictions, judges have to divide your marital estate "equitably," or fairly. Since "fair" and "equitable" don't always mean the same thing, judges in equitable distribution states can award unequal divisions in the presence of certain statutory factors. Depending upon your state, you might have to make peace with the possibility of losing more than half of the investments you made during marriage.

Property Distribution

When courts distribute marital property and debt, they tend to do so with an eye toward economic efficiency. This generally means that if it's possible to distribute any asset intact--such as a 401(k) or a stock account -- the judge is going to bend over backward to make that happen. Distributing an investment account to one party or the other will sometimes result in a division that looks lopsided on paper. This is because judges also take into account the tax consequences of a given division. Because a dollar in an investment account will be taxed before it reaches your hands, it's actually worth less than another dollar in a bank account.

Liquidation

If you do have to liquidate, or cash in, investments in order to achieve a given division, you should factor in -- or ask the judge to factor in -- the costs that are generally going to arise from doing that. Tax-deferred accounts come with both penalties for early withdrawal and taxation at your current rate for any distributions taken. For this reason, if you'll be dividing a retirement account, you may wish to do so after the entry of a Qualified Domestic Relations Order (QDRO) or a decree of separate maintenance. These devices allow people to avoid taxes on divisions incident to divorce. If the investment isn't a tax-deferred retirement or college savings plan, costs still abound. You may have to pay a commission to your broker for liquidating your stocks, and you'll also have to pay capital gains tax on any increase in value over what you paid for them.

Alternatives to Liquidation

If liquidating an investment looks unavoidable in your case, consider agreeing to make equalizing payments--called a "distributive award" or "distributive payment" in some jurisdictions--to the other side in order to avoid the taxes and liquidation costs that may come with cashing something in. State law might allow you to pay the distributive award over time, like alimony, but without the necessity of the other side declaring it on her taxes.