Section Review

In Marital Dissolution, Divide Wealth Not Assets

Attorneys and mediators are negotiating, and judges are approving, separation agreements and divorce settlements that may be unfair and inequitable. At first look these agreements appear to be very fair and equitable. It is taken for granted that in a marital break-up, with respect to finances, three basic things need to be considered: child support, alimony and the division of assets. For long-term marriages with children, a stay-at-home spouse and sufficient assets, a settlement may include child support, generous alimony and the marital home. The purpose of this article is to show that what appears fair and equitable at the time of divorce may actually be unfair and inequitable.

Divorce is a very difficult and emotional time for both the husband and the wife. Aside from custody issues, the most important issues in divorce are the financial decisions to be made. Attorneys for both the husband and the wife try to obtain the best results for their clients. Judges want to see agreements they find to be fair and equitable. To do this, lawyers and judges focus on the settlement at the time of divorce. I believe it is important to see how we look at the financial issues of a marital separation in an entirely different way - that is to consider the concept of value and wealth building.

The Merriam-Webster Dictionary defines wealth as "all property that has a money value or an exchangeable value b: all material objects that have economic utility; especially: the stock of useful goods having economic value in existence at any one time." In other words, the value of assets is the future income they may generate.

For example, I give one of my sons a Nintendo GameCube™ video game that cost $200 and I give my other son $200 in cash. I may have spent the same amount on each son, but I have not given them something of equal value. The Nintendo GameCube™ can be played and enjoyed; however, it depreciates over time. The cash, on the other hand, can be invested and grow in value: the cash has greater value than the Nintendo GameCube™. We use this concept in a divorce setting when we value a business or profit-sharing plan. The value determined is based on the future expected income, all valuations being a forecast of future income. This is why the stock markets fluctuate and individual securities or funds gain and lose value when income expectations change.

As we have all learned from the stock markets, value can be very different, depending on the date of valuation and the time frame we look at. In 1998, the total return for large company stocks was in excess of 28 percent. For 2001, the total return was minus 12 percent.1 Assets also vary in their income-earning capacity. Since 1926, the stock market has averaged an annual return of 13 percent; long-term U.S. treasury bills have averaged an annual return of 5.75 percent. The concepts of annual rates of return, the associated risks and the time frame considered are important factors in understanding how to build wealth. Assets also have different liquidity. Publicly traded stocks are more liquid than a $1 million house. The factors should be taken into account when we develop separation plans. Actually in divorce engagements, we already use these same concepts when we determine the income-earning capacity of an individual. We consider the age (time frame) and health (risk) of the wage earner as well as her annual income. When it comes time to divide the assets and negotiate child support and alimony agreements, too often we fail to consider the value, liquidity and wealth-building potential of the settlement.

The keystone to understanding value is understanding the concept of present value. In non-mathematical terms, present value means that a dollar today is worth more than a dollar one year from today. This assumes that money earns interest over time or that you continue paying or incurring debt. Let's take the $200 cash I gave my son. If he invests the money at 10 percent per year and allows the earnings to accumulate, at the end of 10 years he will have more than $500; however if I do not give him the $200 until 10 years from now, he will only have $200. Present value also is the value of a future stream of earnings. For example, I have a winning Megabucks™ ticket for $2 million to be paid in 20 yearly payments of $100,000; what is the equivalent cash value today if I want to sell the ticket? Assuming I can invest the annual payments at 10 percent, the answer is $850,000.

The concept of present value has many applications in negotiating a financial settlement. Paying a total of $500,000 in alimony in decreasing installments generally has more value to the recipient than receiving the payments in increasing installments (tax traps aside). Cash received from selling the marital home may have more value today then receiving the cash 5 years from now. On the other hand, it may be better to divide the actual proceeds of an unexercised stock option when the option is exercised and the stock sold, if we believe the stock will appreciate greatly in value. What is best needs to be determined case by case.

Another way to look at present value is future value. Future value is the inverse of present value - that is, if I receive an asset or earnings stream today, what will it be worth in the future? For example, if I receive $50,000 in a retirement plan and the earnings continue to earn 10 percent per year, in 10 years the plan will be worth $130,000. If I receive an asset worth $50,000 that is increasing in value at a rate of 5 percent per year, in 10 years it will be worth $81,000. The assets start with the same amount, but they do not have the same value due to the different rates of return. To equate the two assets in terms of future value, I would have to receive an asset valued at $80,000 appreciating at 5 percent per year, to have an asset worth $130,000 in 10 years. Equating assets based upon their future value is a radical departure from the way we currently look at the division of assets.

To understand how this can impact the evaluation of a proposed settlement, I am going to show several different scenarios to illustrate the points discussed above. The numbers used are for illustration purposes and are not intended to reflect an actual settlement. I have also made certain assumptions to simplify the examples. First, the earnings on investments and retirement plans are assumed to be reinvested. Second, the husband will first invest his excess cash flow in a retirement plan (up to 15 percent of his salary) and then in marketable securities. Though I focus on the husband as the primary wage earner; this could be either the husband or the wife. I have also assumed that there are two young children in the marriage and that the non-primary wage earner will be the custodial parent.

Example: Wife keeps home

The first example (Table 1) is what looks to be a very fair agreement, with the wife (custodial parent) keeping the marital home. In this settlement, the wife receives the marital home with equity of $75,000 and the husband receives his investment and retirement accounts. The wife receives $17,000 in alimony and $15,600 in child support in addition to part-time employment income. From this she pays the mortgage and housekeeping expenses and other costs of living.

Chart 1 shows the differences in the increase in wealth over a 10-year period. As can be seen, at the end of 10 years the husband's accumulated wealth is almost $200,000 higher than the wife's. The differential is getting greater at a more rapid rate.

Table 2 shows the flow of income by year. The difference between the husband's growth in wealth and the wife's is that the marital home gains value more slowly than the husband's investments and retirement plan. From this table, we can see that the husband's wealth grows more quickly due to the costs of owning the home and because the investments and retirement plan have a greater annual return than does the marital home. Nationally, the value of a home for the period 1985-2001 has increased 4.5 percent per year and in New England at 5.3 percent per year.2 For the same period the stock market has increased 8 percent-10 percent. The growth in the value of the home shown above is a combination of increasing equity resulting from continuing mortgage payments and the increase in value at 4.5 percent per year. For the last four years, growth in the value of homes in New England has outpaced returns from the stock market; however, it would be wrong to look at the last four or five year New England growth rate in home values as this is too short a period to draw long-term conclusions from. We tend to take for granted that keeping the marital home is best; however doing so may leave the custodial parent and mother financially strapped and unable to provide for her retirement.

Example: Husband, wife split assets

The next example assumes the same facts as above, but in this case the marital home is sold at the time of divorce with the proceeds from the sale, the husband's investments, and the husband's retirement plan being divided equally (Table 3).

As Chart 2 shows, the increase in wealth is now much more equitable. Those comfortable reading charts will notice that the total wealth of the husband and wife is less than in the first scenario. In this scenario, there are children who will be attending college in 10 or so years. It is better for the wife to keep the marital home and have the husband pay most of the college expenses.

Example: House has higher value

Now let us look at a case where the marital home is substantially higher in value and the husband earns more money. The home has a higher value of $500,000 with equity of $75,000 and accordingly a higher mortgage payment (Table 5). The husband's income is also much higher, as is alimony. Chart 3 shows the differential is now more than 2 1/4 times greater for the husband than the wife. This time, a substantial part of the discrepancy is the husband's cash flow available for investing.

Example: Wife keeps home, receives assets

For the last scenario, instead of selling the house, the wife will keep the marital home and receive additional assets from the husband. In addition to keeping the marital home, she will receive 50 percent of the investments and 50 percent of the retirement plan (Table 7).

These assets accumulate value at a faster rate than the marital home increases in value; the wife's net worth in 10 years increases by more than 100 percent over the first scenario. Chart 4 shows this very dramatically. Table 8 shows how the growth in wealth flows.

End notes

1. Stocks, Bonds, Bills, & Inflation, Valuation Edition, 2002 Yearbook, Ibbotson Associates, for this an the following facts stated in this paragraph.[back]

2. Office of Federal Housing Enterprise Oversight, OFHEO indexes: 2001 Q4, U.S. Combined and Census Division Indexes - (1980 Q1=100). Downloaded from http://www.ofheo.gov/house/hpi_frame.html, 5/10/2002.[back]

Table 1 [Back]
Status before and after divorce
Wife keeps home
    before divorce wife husband
Marital estate
  marital home 250,000 250,000  
  mortgage -175,000 -175,000  
  investments 50,000   50,000
  retirement plan 25,000   25,000
  Total at settlement 150,000 75,000 75,000
Income
  wages   15000 81500
  alimony ($298/week) 15500 -15500
  child support   15600  
  Total income   46100 66000
Expenses
  income taxes   -2,400 -13,100
  child support   -15,600  
  mortgage   -13,800  
  home expenses -11,100  
  rent   -24,000  
  living exenses -18,200 -12,000
  Total expenses -45,500 -64,700
  Available for savings 600 1,300


Table 2 [Back]
Growth in wealth • Wife keeps house
Assumptions: after-tax appreciation on investments: 7% pretax appreciation on investments: 10%
Husband's net worth
year take home (3.5% inc) child support rent (2.5% inc) living expenses (2.5% inc) net overag'e amount to retirement amount to savings cumulative retirement cumulative savings net worth    
  0 52,900   -15,000 -12,000 25,000 50,000 25,000 50,000 0 75,000    
  1 54,800 -15,600 -15,400 -12,300 11,500 8,200 3,300 36,100 58,500 94,600    
  2 56,700 -15,600 -15,800 -12,600 12,700 8,500 4,200 48,600 68,800 117,400    
  3 58,700 -15,600 -16,200 -12,900 14,000 8,800 5,200 62,700 81,100 143,800    
  4 60,800 -15,600 -16,600 -13,200 15,400 9,100 6,300 78,500 95,800 174,300    
  5 62,900 -15,600 -17,000 -13,500 16,800 9,400 7,400 96,200 113,200 209,400    
  6 65,100 -15,600 -17,400 -13,800 18,300 9,800 8,500 116,100 133,400 249,500    
  7 67,400 -15,600 -17,800 -14,100 19,900 10,100 9,800 138,300 157,000 295,300    
  8 69,800 -15,600 -18,200 -14,500 21,500 10,500 11,000 163,200 184,300 347,500    
  9 72,200 -15,600 -18,700 -14,900 23,000 10,800 12,200 190,900 215,500 406,400    
  10 74,700 -15,600 -19,200 -15,300 24,600 11,200 13,400 221,800 251,100 472,900    
                           
Wife's net worth
Year take home (3.5% inc) child support mortgage home expenses (4.5% inc) living expenses (2.5% inc) net overage (underage) amount to retirement amount to savings cumulative retirement cumulative savings net home worth
  0 28,100   -175,000           - - 75,000 75,000
  1 29,100 15,600 -13,800 -11,600 -18,700 600   600 - 600 90,400 91,000
  2 30,100 15,600 -13,800 -12,100 -19,200 600   600 - 1,300 106,600 107,900
  3 31,200 15,600 -13,800 -12,600 -19,700 700   700 - 2,200 123,600 125,800
  4 32,300 15,600 -13,800 -13,200 -20,200 700   700 - 3,200 141,500 144,700
  5 33,400 15,600 -13,800 -13,800 -20,700 700   700 - 4,300 160,400 164,700
  6 34,600 15,600 -13,800 -14,400 -21,200 800   800 - 5,600 180,500 186,100
  7 35,800 15,600 -13,800 -15,000 -21,700 900   900 - 7,100 201,600 208,700
  8 37,100 15,600 -13,800 -15,700 -22,200 1,000   1,000 - 8,900 223,900 232,800
  9 38,400 15,600 -13,800 -16,400 -22,800 1,000   1,000 - 10,800 247,500 258,300
  10 39,700 15,600 -13,800 -17,100 -23,400 1,000   1,000 - 12,900 272,400 285,300


Table 3 [Back]
Status before and after divorce
Home is sold
    before divorce wife husband
Marital estate   250,000    
  marital home -175,000 37,500 37,500
  mortgage      
  investments 50,000 25,000 25,000
  retirement plan 25,000 12,500 12,500
  Total at settlement 150,000 75,000 75,000
 
Income
  wages   15,000 81,500
  alimony ($298 per week) 15,500 -15,500
  child support   15,600  
  Total income   46,100 66,000
 
Expenses
  income taxes   -3,500 -13,100
  child support     -15,600
  mortgage      
  home expenses    
  rent   -24,000 -24,000
  living exenses -18,200 -12,000
  Total expenses -45,700 -64,700
  Available for savings 400 1,300


Table 4 [Back]
Growth in wealth • Wife keeps house
Assumptions: after-tax appreciation on investments: 7% pretax appreciation on investments:10%
Husband's net worth
  year take home (3.5% inc) child support rent (2.5% inc) living expenses (2.5% inc) net overage amount to retirement amount to savings cumulative retirement cumulative savings net worth
  0 52,900   -24,000 -12,000   12,500 62,500 12,500 62,500 75,000
  1 54,800 -15,600 -24,600 -12,300 2,300 2,300 - 16,200 68,800 85,000
  2 56,700 -15,600 -25,200 -12,600 3,300 3,300 - 21,300 75,700 97,000
  3 58,700 -15,600 -25,800 -12,900 4,400 4,400 - 28,100 83,300 111,400
  4 60,800 -15,600 -26,400 -13,200 5,600 5,600 - 36,800 91,600 128,400
  5 62,900 -15,600 -27,100 -13,500 6,700 6,700 - 47,500 100,800 148,300
  6 65,100 -15,600 -27,800 -13,800 7,900 7,900 - 60,500 110,900 171,400
  7 67,400 -15,600 -28,500 -14,100 9,200 9,200 - 76,200 122,000 198,200
  8 69,800 -15,600 -29,200 -14,500 10,500 10,500 - 94,800 134,200 229,000
  9 72,200 -15,600 -29,900 -14,900 11,800 10,800 1,000 115,600 148,700 264,300
  10 74,700 -15,600 -30,600 -15,300 13,200 11,200 2,000 138,900 165,700 304,600
 
Wife's net worth
  year take home (3.5% inc) child support rent (2.5% inc) living expenses (2.5% inc) net overage amount to retirement amount to savings cumulative retirement cumulative savings net worth
  0 27,000         12,500 62,500 12,500 62,500 75,000
  1 27,900 15,600 -20,000 -18,700   - - 13,800 68,800 82,600
  2 28,900 15,600 -20,500 -19,200 4,800   4,800 15,200 80,700 95,900
  3 29,900 15,600 -21,000 -19,700 4,800   4,800 16,700 93,800 110,500
  4 30,900 15,600 -21,500 -20,200 4,800   4,800 18,400 108,200 126,600
  5 32,000 15,600 -22,000 -20,700 4,900   4,900 20,200 124,200 144,400
  6 33,100 15,600 -22,600 -21,200 4,900   4,900 22,200 141,800 164,000
  7 34,300 15,600 -23,200 -21,700 5,000   5,000 24,400 161,200 185,600
  8 35,500 15,600 -23,800 -22,200 5,100   5,100 26,800 182,700 209,500
  9 36,700 15,600 -24,400 -22,800 5,100   5,100 29,500 206,300 235,800
  10 38,000 15,600 -25,000 -23,400 5,200   5,200 32,500 232,400 264,900


Table 5 [Back]
Status before and after divorce
Wife keeps home
    before divorce wife husband
Marital estate
  marital home 500,000 500,000  
  mortgage -425,000 -425,000  
  investments 100,000 42,000 58,000
  retirement plan 59,000   59,000
  Total at settlement 234,000 117,000 117,000
Income
  wages   23,800 150,000
  alimony ($700 per week) 36,400 -36,400
  child support   15,600  
  Total income   75,800 113,600
Expenses
  income taxes   -5,300 -28,300
  child support   -15,600  
  mortgage   -35,000  
  home expenses -11,100  
  rent   -30,000  
  living exenses -24,000 -12,000
  Total expenses -75,400 -85,900
  Available for savings 400 27,700


Table 6 [Back]
Growth in wealth • Wife keeps house
assumptions: after-tax appreciation on investments: 7% pretax appreciation on investments: 10%
Husband's net worth
  year take home (3.5% inc) child support rent (2.5% inc) living expenses (2.5% inc) net overage amount to retirement amount to savings cumulative retirement cumulative savings net worth  
  0 85,300   -30,000 -12,000   59,000 58,000 59,000 58,000 117,000  
  1 88,300 -15,600 -30,800 -12,300 29,600 13,200 16,400 78,800 81,000 159,800  
  2 91,400 -15,600 -31,600 -12,600 31,600 13,700 17,900 101,100 107,900 209,000  
  3 94,600 -15,600 -32,400 -12,900 33,700 14,200 19,500 126,100 139,200 265,300  
  4 97,900 -15,600 -33,200 -13,200 35,900 14,700 21,200 154,100 175,400 329,500  
  5 101,300 -15,600 -34,000 -13,500 38,200 15,200 23,000 185,500 217,100 402,600  
  6 104,800 -15,600 -34,900 -13,800 40,500 15,700 24,800 220,500 264,900 485,400  
  7 108,500 -15,600 -35,800 -14,100 43,000 16,300 26,700 259,700 319,400 579,100  
  8 112,300 -15,600 -36,700 -14,500 45,500 16,800 28,700 303,300 381,500 684,800  
  9 116,200 -15,600 -37,600 -14,900 48,100 17,400 30,700 351,900 451,900 803,800  
  10 120,300 -15,600 -38,500 -15,300 50,900 18,000 32,900 406,000 531,600 937,600  
Wife's net worth
Year take home (3.5% inc) child support mortgage home expenses (4.5% inc) living expenses (2.5% inc) net overage (underage) amount to retirement amount to savings cumulative retirement cumulative savings home net worth
0 28,100   -425,000         42,000   42,000 75,000 117,000
1 29,100 15,600 -35,000 -11,600 -24,600 -26,500       46,200 90,400 136,600
2 30,100 15,600 -35,000 -12,100 -25,200 -26,600       50,800 106,600 157,400
3 31,200 15,600 -35,000 -12,600 -25,800 -26,600       55,900 123,600 179,500
4 32,300 15,600 -35,000 -13,200 -26,400 -26,700       61,500 141,500 203,000
5 33,400 15,600 -35,000 -13,800 -27,100 -26,900       67,700 160,400 228,100
6 34,600 15,600 -35,000 -14,400 -27,800 -27,000       74,500 180,500 255,000
7 35,800 15,600 -35,000 -15,000 -28,500 -27,100       82,000 201,600 283,600
8 37,100 15,600 -35,000 -15,700 -29,200 -27,200       90,200 223,900 314,100
9 38,400 15,600 -35,000 -16,400 -29,900 -27,300       99,200 247,500 346,700
10 39,700 15,600 -35,000 -17,100 -30,600 -27,400       109,100 272,400 381,500


Table 7 [Back]
Status before and after divorce
Wife sells home & uneven division of assets
    before divorce wife husband
Marital estate
  marital home 500,000 500,000  
  mortgage -425,000 -425,000  
  investments 100,000 50,000 50,000
  retirement plan 59,000 29,500 29,500
  Total at settlement 234,000 154,500 79,500
Income
  wages   23,800 150,000
  alimony ($700 per week) 36,400 -36,400
  child support   15,600  
  Total income   75,800 113,600
Expenses
  income taxes   -5,300 -28,300
  child support     -15,600
  mortgage   -35,000  
  home expenses -11,100  
  rent     -30,000
  living exenses -24,000 -12,000
  Total expenses -75,400 -85,900
  Available for savings 400 27,700


Table 8 [Back]
Growth in wealth • Wife keeps house & receives additional assets
assumptions: after-tax appreciation on investments: 7% pretax appreciation on investments: 10%
Husband's net worth
  year take home (3.5% inc) child support rent (2.5% inc) living expenses (2.5% inc) net overage amount to retirement amount to savings cumulative retirement cumulative savings net worth  
  0 85,300   -30,000 -12,000   59,000 58,000 59,000 58,000 117,000  
  1 88,300 -15,600 -30,800 -12,300 29,600 13,200 16,400 78,800 81,000 159,800  
  2 91,400 -15,600 -31,600 -12,600 31,600 13,700 17,900 101,100 107,900 209,000  
  3 94,600 -15,600 -32,400 -12,900 33,700 14,200 19,500 126,100 139,200 265,300  
  4 97,900 -15,600 -33,200 -13,200 35,900 14,700 21,200 154,100 175,400 329,500  
  5 101,300 -15,600 -34,000 -13,500 38,200 15,200 23,000 185,500 217,100 402,600  
  6 104,800 -15,600 -34,900 -13,800 40,500 15,700 24,800 220,500 264,900 485,400  
  7 108,500 -15,600 -35,800 -14,100 43,000 16,300 26,700 259,700 319,400 579,100  
  8 112,300 -15,600 -36,700 -14,500 45,500 16,800 28,700 303,300 381,500 684,800  
  9 116,200 -15,600 -37,600 -14,900 48,100 17,400 30,700 351,900 451,900 803,800  
  10 120,300 -15,600 -38,500 -15,300 50,900 18,000 32,900 406,000 531,600 937,600  
Wife's net worth
year take home (3.5% inc) child support mortgage home expenses (4.5% inc) living expenses (2.5% inc) net overage (underage) amount to retirement amount to savings cumulative retirement cumulative savings home net worth
0 54,900   -425,000       50,000 29,500 50,000 29,500 75,000 154,500
1 56,800 15,600 -35,000 -11,600 -24,600 1,200   1,200 55,000 33,700 106,500 195,200
2 58,800 15,600 -35,000 -12,100 -25,200 2,100   2,100 60,500 39,300 139,700 239,500
3 60,900 15,600 -35,000 -12,600 -25,800 3,100   3,100 66,600 46,500 174,800 287,900
4 63,000 15,600 -35,000 -13,200 -26,400 4,000   4,000 73,300 55,400 212,000 340,700
5 65,200 15,600 -35,000 -13,800 -27,100 4,900   4,900 80,600 66,100 251,100 397,800
6 67,500 15,600 -35,000 -14,400 -27,800 5,900   5,900 88,700 78,900 292,400 460,000
7 69,900 15,600 -35,000 -15,000 -28,500 7,000   7,000 97,600 94,100 336,000 527,700
8 72,300 15,600 -35,000 -15,700 -29,200 8,000   8,000 107,400 111,900 382,100 601,400
9 74,800 15,600 -35,000 -16,400 -29,900 9,100   9,100 118,100 132,600 430,600 681,300
10 77,400 15,600 -35,000 -17,100 -30,600 10,300   10,300 129,900 156,700 482,000 768,600


chart 1
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chart 2
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chart 3
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chart 4
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