Couples in the throes of divorce settlement negotiations must address both the concrete and the abstract. The concrete aspects of marital property settlements are somewhat intuitive; examples include houses, cars, other real and personal property, and often a lump sum of cash and marketable securities.
But when the non-moneyed spouse is offered a lump-sum divorce settlement – either as an addition to, or as an alternative to ongoing maintenance and support payments – the lump-sum payment, the engine that will be required to support your future lifestyle, often becomes pretty abstract.
This is because money itself is inherently abstract. Rather than having an intrinsic value, money represents the vehicle by which your current and future lifestyle is funded.
Stated somewhat differently, when it comes to supporting your lifestyle, the purpose of money is to generate the ongoing cash flow that allows you to purchase goods and services, now and in the future. Further adding to this abstraction is the fact that the path between the current lump sum of cash to the funding of your future lifestyle is nonlinear; there are many variables – some of which often are beyond your control.
When considering the adequacy of a lump sum divorce settlement, the most significant variables to consider include planning for the growth of your money (investment returns), which itself is subject to a plethora of financial variables, as well as the cost of supporting your future lifestyle, which is subject to both inflation and your evolving needs. It is extremely difficult for even the financially savvy to model how much money in today’s dollars is needed to fund a person’s future lifestyle, or conversely, what would one’s future lifestyle look like based on receiving a lump sum of money today. This is the time, during settlement negotiations, not afterwards, when engaging an experienced professional financial planner can be extremely helpful.
Unlike many attorneys, a financial planner with experience working on matrimonial matters knows how to navigate these financial abstractions and interpret and communicate alternative scenarios to his or her client. When we take on matrimonial engagements, our primary tool is a multi-year cash flow projection that is built on reasonable assumptions.
Stated simply, a cash flow is a listing of your likely future expenses, along with the sources of cash that will be required to fund them. We start by listing monthly expenses, generally based on the recent past, modified for anticipated post-divorce adjustments, so the result looks somewhat like a monthly budget. After our client is reasonably confident of their monthly expenses, we annualize them for a cleaner looking analysis that may extend 10, or even 20 years into the future.
Anticipating future expenses is difficult, and projecting the sources of cash required to fund these expenses is even more difficult. Investment returns are highly dependent on your portfolio asset allocation, which in turn is dependent on factors such as your investment risk tolerance (itself a complicated process), your age, other available economic resources and the ability to replace lost capital. Estimates for investment rates of return should be conservative with plenty of margin for error, as the financial markets do not always cooperate with our expectations and needs. Also, the income tax bite on portfolio income is an extremely important consideration. Often, taxes are a household’s largest cash outflow. Once completed, a thoughtful multi-year cash flow projection becomes the rock of your financial planning as it quantifies your financial lifestyle down the road. Generally, we update our clients’ cash flows annually or as they experience changes in their financial lives.
For most, the process of negotiating the financial settlement leading to divorce is the most anxiety-producing aspect of an entirely unpleasant ordeal. This is unchartered territory that requires a tremendous commitment of time and focus. The decisions you make, or settlements to which you agree, likely will have an enormous impact on your ability to fund your future.
This is a difficult time to go it alone. An experienced planner who has gone through this exercise with many other clients can be extremely valuable. Seek a credentialed advisor who not only has an intimate knowledge of tax laws and portfolio construction, but also is intuitive and emotionally intelligent. Ideally, rather than just seeking transactional assistance, you want to work with a planner who can support your ongoing financial needs into the future, when hopefully, the divorce process is little more than an unpleasant memory.