Retirement and Divorce
Novelist Margaret Atwood says that “A divorce is like amputation; you survive, but there's less of you.” Most certainly there's less of your financial assets. If you're undergoing divorce, take time to develop a new financial plan that works for the new, single you. Or, are you thinking about raiding your IRA for a house down payment? That's a very expensive idea.
By Barbara Eisner Bayer (TMF Venus) and Ann Coleman (TMF AnnC)
November 8, 2000
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Q.I'm 47 years old and, until recently, my retirement plans have been going as planned. We were going to have enough to travel and have an easy life in retirement through my 401(k).�Seven weeks ago, my wife of 24 years announced that we were getting divorced, totally out of the blue for me. Now that my plan is essentially halved, should I invest more aggressively, or should I hold the present course? I planned on retiring at 59, but it doesn't look like that is possible now.
A. You sound all bummed out. Novelist Margaret Atwood says that "A divorce is like amputation; you survive, but there's less of you." I'm pretty sure she was referring to the emotional trauma of the ordeal, but having one's retirement dreams (not to mention cash) slashed abruptly like that calls for a tourniquet, too.
Your retirement plans might have to be altered, but not necessarily. For one thing, you might find that your retirement funds aren't as affected as you expect. It depends on the settlement. Your wife might prefer to keep a larger portion of other property, like the house, in exchange for some of her share of the retirement funds. Or not. Settlements don't have to be cut-and-dried, 50-50 on every item.
Even if you find your retirement funds cut in half, all is not lost. You still have time on your side since you weren't planning to retire for another 12 years. You have the time to invest more aggressively if you like. Heck, you have time to find another lady with her own 401(k), right?
So, why are you looking on the dark side? Well, that's obvious. You feel like you're on the wrong end of a dirty trick. You need some time to heal. Changing your investing style right now might seem like good therapy, but you don't want to be investing out of a feeling of desperation. Take some time to develop new goals and explore more aggressive investing strategies, but don't take on more risk than you are comfortable with, and don't make abrupt changes without adequate research. Our Retirement Center has lots of help on developing goals and assessing the risks of various plans.
One of us (we aren't saying who) actually came to The Motley Fool in much the same situation you are in today. Obsessing over what to do with post-divorce retirement funds turned out to be the start of a whole new life. That might not sound very encouraging to you right now, but if you look for opportunities instead of focusing on losses, you will find them.
Q. I am looking to buy a home for the first time and my IRA is the only account I have enough money in for a down payment. When I left my old job I had to roll my 401(k) over into an IRA because I wasn't working. Otherwise, I would have rolled it over into the new company's 401(k), which I've done in the past. Can you please give me some strong, sound advise as to what I can do?
A. I take it you are thinking about the first-time home buyer's rule that says you don't have to pay a penalty on IRA withdrawals if you use the money for a first-time home purchase. First, have you read the fine print? You're limited to $10,000 under that exception. But, even if you don't have to pay the 10% penalty, taxes will gut your buying power.
The problem is that the money in your IRA has never been taxed. When you withdraw it, it becomes taxable income and gets added to your current salary. (This applies to Roth IRAs, too, unless one is withdrawing contributions on which taxes have already been paid, or unless the withdrawal is made after age 59 1/2 when the money can be withdrawn tax-free anyway.)
OK, say you take out your maximum of $10,000. That immediately boosts your taxable income by $10,000. You don't have to pay the penalty, but if you are in the 28% tax bracket and live in a state with a 5% income tax, that's 33% of your cash gone right off the top. So, your $10,000 withdrawal will net you only $6,700 for your down payment.
If you actually need, say, $20,000 in cash, you'll need to withdraw almost $34,000 from your IRA, because 40% of your withdrawal will go straight to Uncle Sam and Cousin State (33% on all of it and 10% on the $25,000 over the amount that is excluded from the penalty).
It could be even worse: If you are close to the top of the 28% tax bracket, then your withdrawal could push you into the 31% bracket, meaning some of your withdrawal would be taxed at that higher rate. Anyone in the 36% tax bracket could easily lose half of his withdrawal to taxes and penalties. Even if you managed to keep your income (including the IRA distribution) in the 15% tax bracket, you're still throwing away a big chunk of change. And we haven't even gotten started on what that money would be worth when you retire!
Home ownership is a laudable goal, but unless your IRA is really, really over-funded (how often does that happen?), taking the cash out of it to buy a home is a pretty bad deal. (This applies in spades when it comes to paying off debts.)
Do you have other options? Options might include getting a very low down payment loan, borrowing the cash from a family member, looking for a lease-purchase deal, or sticking it out as a renter for a few more years while saving like mad. That last option isn't very appealing because rent isn't tax-deductible like your mortgage interest payments would be, but if you are in an area with an extremely hot real estate market, it might pay off to take some time to reassess your alternatives and bargain hunt.
So, what would that $10,000 be worth in 30 years? If you stuck it in an index fund and the market averaged the same return for the next 30 years that it has since 1926 (11.3%), it would be worth about $250,000. Patience pays.
