The phrase financial risk management is not often talked about in context to a divorce. Yet all too often this process needs to be in place to manage each party’s divorce risks.
What is financial risk management in context to a divorce?
Financial risk management focuses on the financial risks you could experience and need to manage as your divorce changes form in real time right before your eyes. Yes, this happens all of the time. Believe it or not a single decision can create a lot of financial pain in your future. The way you say something to others who are involved in your divorce process can inflame another person’s thinking process. If the other person’s thinking process goes down the wrong path they could seek some form of compensation which could place your future financial in harm’s way. Knowing how to recover from these unintentional mishaps is only one piece of the puzzle to manage your financial risks.
There are numerous financial risks that arise in a divorce. Some more straight forward ones are:
- Liquidity risk – When an investment (e.g. real estate, retirement account, etc.) cannot be liquidated quickly enough before the price changes in the market
- Tax risk – Where certain assets have specific tax attributes that need to be managed to minimize the divorcing party’s tax exposure when allocating assets, selling off certain properties, etc
- Asset allocation risk – Where assets are not properly allocated between the parties and one party unknowingly assumes more risk than the other
- Credit risk – Where the strength of your credit declines after your divorce as a result of decisions you made during your divorce
- Insurance risk – Where your options are now limited as a result of the new profile created from your divorce
- Settlement structure risk – Where the settlement structure is not designed in context to your true life’s needs. It is common for risk to enter the picture when practitioners use a formula based approach to design the settlement structure as opposed to one specifically designed for your situation.
- Financing risk – Where the divorce requires outside financing to fund the separation yet there are few, if any, ways to get the divorce ‘financed’. This also relates to a party’s ability to obtain financing after the divorce as a result of their new profile created from their divorce.
There are many other types of financial risks one might experience during a divorce or after one is finalized. Each person’s situation is unique to their life. Each risk needs to be identified and diligently managed to properly position your financial life that awaits you. Yet, this all needs to be done before your divorce is finalized. Otherwise you will not achieve the flexibility or growth you desire.
Some simple examples to provide some context
Imagine you have two pieces of real estate you want to divide between you and your spouse. Someone may suggest to simply split the value of the properties down the middle and reconcile the difference between the net equity that exists in each property. On the surface this sounds logical.
Yet, if you had a financial risk manager on your team you would witness a different approach and vastly different type of thinking too. The financial risk manager would quickly point out the approach outlined above is not the optimal way to structure your financial settlement. The recommended property allocation has a tax risk associated to it. Your financial risk manager would advise you to consider buying each other out of the homes without having any cash change hands per se. Why? Think back when you originally purchased your home. The government will calculate the gain on the sale of your home based on the difference between what you paid for it and the ultimate selling price. Given this is the way the calculation will be performed, if you do not increase your purchase price through your divorce process you will not increase what is commonly referred to as your cost basis. In the future you will pay more in taxes than you truly need to. Yet, if you buy each other out through a tax free exchange and increase your cost basis then you can reduce your future tax gain. Note: There is a special section of the tax code that allows you to do a tax free exchange which is beyond the scope of this article.
Through this financial risk management strategy, depending on the size of your tax gain, you could reduce your future cash outlay to the government. The government is one of many stakeholders to your divorce process. In this example your financial risk manager would save you hundreds of thousands of dollars, if not millions in some situations, so you can keep those monies as part of your investment portfolio.
Here is another example about real estate too. Assume there is only one home in the marital estate. Through negotiations you and your spouse decide you will keep the home and your spouse will receive other assets in your marital estate. On the surface this may sound logical as you want to remain in the home. Yet, if you had a financial risk manager on your side you would be asked to re-evaluate this decision.
Your financial risk manager would ask you questions such as:
- How has the housing market performed over time?
- Will this ‘holding’ appreciate as much as the other holdings?
- Where did the monies come from to pay for the down payment?
- What was the proportion of each spouse’s income to the marital estate when the home was purchased?
- Which funds were used to pay down the mortgage?
- What is your financial capability to carry the current mortgage in the future?
- How much will the legacy liabilities cost you over time to replace?
You can easily assume more risk if you accept the home “as is” without asking the right questions up front. This single decision to keep the home could introduce thousands of dollars of additional financial risk into your life. A financial risk manager would share you need to look at your home as if you are a third party buyer. What issues would a buyer raise before buying the home?
These are just two simple examples. There are many and they vary across the board. Even simple situations can have intertwining issues where parties unknowingly leave a lot of money on the table which need to be taken into account. Your financial risk manager would bring you through a deep and comprehensive divorce diagnostic assessment to clearly define your positions and risks you could assume as a result.
The value of a financial risk manager on your side during your divorce process
If you are not skilled at uncovering financial risk then you may just be saddled with a lot of it after your divorce is finalized. In fact you may be skilled at financial matters but not when it comes to a divorce.
When it comes to your life, there are a lot of pieces to it that likely need to be managed. On the surface issues may seem simple. Yet life shows all of us that issues are usually more complex than what appears on the surface. Even simple situations have issues associated to them that can cost you a lot of money.
In a divorce process you will need someone to help you:
- uncover risks and opportunities that hide in your data
- evaluate how your decisions and communications impact others involved in the process
If you can find someone who can function as your financial risk manager you will find a professional who will manage your financial outcomes at all times throughout the process. This financial risk manager will likely provide you a significant return on your investment that you spend on her or his services. How so?
A single decision can create a ripple effect that can impact the rest of your life. If you cannot see the issues yourself, then you will likely experience compounded financial burdens later in life that you will have wished you addressed and resolved during your divorce process. Your financial risk manager is similar to, yet not exactly like, taking out an insurance policy. Your financial risk manager assesses your risks upfront so you know where things stand. If your issues are truly simple then there is no reason to continue using a financial risk manager in your process. Yet, if they are complex you have just found your weight in gold.
Financial risks unknowingly arise in your communications with other parties and in each decision you make. You have to know how each decision will influence the next decision. The goal is to manage both current and future risks that can arise. How information is presented and when you share the information will unintentionally infuse risk into your divorce process.
There are certain decisions you will make that do not seem to have a connection to your financial outcomes. In our experience, almost every decision does. So, be careful how you shape decisions and how you communicate too. Both are very sensitive in this process and can land you in hot water. We find it takes 5 minutes for people to lose (or save) thousands and even millions of dollars. It is all about whether the professional you engage has the trained eye and knows how to read the landscape to manage your financial risks before they happen.
As you interview professionals ask them whether they understand how internal controls enter a divorce process. Ask them the type of financial risk management training they have in their backgrounds. The deeper the experience the clearer and more comprehensive solution you will gain for you and your family. If the person comes up with an empty response you will know they do not have much financial risk management expertise which is an essential skill you will need on your professional advisory team.
About the Author
Larry Smith is a Founding Partner of Divorce Outcomes, a specialized professional services firm that manages all of the financial aspects in a divorce process. Since 2003 he has worked as a trusted financial advisor, financial advocate, divorce architect and technical financial expert; he is not an attorney. He is an alumni of KPMG and Andersen with expertise in technical accounting, forensics, sophisticated taxation, management consulting, risk management, advanced process engineering, business combinations, divorce management, multi-party negotiations, advanced quality analytics and cognitive performance technologies. Since 1986 Larry has been advising individuals and organizations about innovative financial solutions to resolve complex financial challenges that arise in life and in business.
For both personal and business divorces, Larry is considered an expert in divorce strategies, divorce process management, financial divorce architecture, financial risk management, taxation for divorces, financial divorce forensics, advanced divorce analytics, financial divorce negotiations and mediation, business valuations and sophisticated equity structures. He helps clients shape complex financial decisions, manage communication risks and ever-changing negotiating positions to strategically preserve or grow wealth from these types of transactions.
If You Have a Question
If you have a question, feel free to contact me at [email protected] or 617-680-5222. The call is free. I will spend 30–60 minutes with you. I will provide you an honest assessment as to where I think you are positioned in your divorce process or answer any questions you have. I may provide you some guidance, insight or advice that you can take with you as you wish. There is no obligation to move forward. The phone call is designed to ease your fears, provide you some options to pursue and a potential road to run on that can lead you down a path to achieve a successful outcome.
About Divorce Outcomes
Divorce Outcomes is a specialty services firm that helps people both domestically and internationally manage all of the financial decisions that arise in their divorce process. We are not attorneys. We are financial experts who partner with our clients as their personal financial advocates. We help our clients manage their divorce process, uncover hidden financial risks, architect divorce solutions, manage ever-changing negotiating positions, communicate complex financial matters and close the divorce process as soon as possible with a goal to arrive at the best outcomes possible. Throughout the process we evaluate the current state of our clients’ financial lives with an objective to best reposition their future. We do not sell any products. We simply raise issues that are in our clients best interest. Our clients share with us we:
- unfold, analyze and repackage their financial life so they are well positioned after their divorce
- preserve the value of their business or marital estate
- continuously strive to provide a return on our services
- build balanced financial solutions grounded in evidence
- find ways to make our client, and at times both parties, money through the process
- design their divorce to work for them and their family’s life
- provide mental clarity to make decisions
- reduce the total process time from start to close
- minimize the stress and unpleasant memories that can last a lifetime
As we reach an agreed upon settlement structure, we help our clients identify a fitting attorney who can leverage the financial solution to draft and record the requisite legal documents. Where outcomes are at risk from a traditional process, we function as expert financial negotiators or financial mediators to turn around the situation and achieve our client’s desired outcomes.
This communication is for general informational purposes only which may or may not reflect the most current developments. It is not intended to constitute formal advice or a recommended course of action as every person’s situation is unique and different. The information here is not intended to be, and should not be, relied upon by the recipient to make a decision without professional guidance.