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Should Couples Get a Prenup?

This article was written by Flexo in Family and Life. 18 comments.

Prenuptial agreements are on the rise, as more individuals are concerned about losing their assets in the wake of the recession. Prenups, when handled correctly, can protect an individual’s assets in the increasingly likely event of divorce. Without a prenup explicitly defining how assets should be divvied up, if a divorce occurs, any income earned during the marriage, including any money added to retirement accounts, could be split between the two individuals. Depending on the state, this split could be 50% to each or it could be some other method considered fair by the courts.

Regular earned income isn’t the only type of wealth that could be affected. Any increase of the value of an asset, whether stock investments or a business, that occurred during the marriage could be considered marital property and divided by a court. For example, even if one spouse purchased a house before marriage, the increase in the value of the house during the marriage will likely be distributed partially to the spouse who doesn’t own the house. A business that’s started years before the marriage but thrives during the marriage, even if the non-owner spouse is not involved with the business, could be split in the event of a divorce.

For someone who has worked hard his or her entire life to build a solid financial future, a divorce is one of the most financially devastating events one can endure. We buy insurance to protect ourselves against loss of health, we diversify investments and choose an appropriate asset allocation to help shield us from financial downturns. A prenup is just another way of protecting assets.

Although we don’t feel edgy about discussing insurance with someone we plan to spend the rest of our lives with, prenups are one of the most taboo topics within the broader taboo topic of money. No one wants to seem greedy. The point of marriage is to make two lives one, not to continue living two independent lives within the same household. A prenup would indicate that divorce is an option down the road, and many couples would not be interested in facing that possibility at a time, before marriage, when the only thought should be living a happy life together.

Classically, couples who opt for prenups usually have one or two individuals who fall into these descriptions:

Wealthy, either by inheritance or by effort. When one individual has a much higher level of wealth than the other, the wealthier spouse often wants to protect his or her money in the event of a divorce.
Unequal income. Like an unequal net worth, unequal income or income potential can tilt the balance of power within a marriage. A prenup can either protect the balance or protect the tilt.
A business owner. For someone who owns a business, a divorce could mean the end of that business. Selling the business is an option for liquidating enough cash to pay for the expenses of breaking up a marriage. If the business is location-based and the owner prefers to move, this, too, could have a devastating affect on the business.

State laws govern prenuptial agreements, and each state falls into one of two categories. In 41 states, divorce without a prenuptial agreement falls under equitable distribution, where the court considers the individual case, circumstances, and finances to determine the most fair division of assets. In the remaining nine states, courts divide all marital property. Prenups can override these state defaults.

Prenuptial agreements are often in the news when celebrity couples move towards marriage. Most recently, Kim Kardashian, who earns about $12 million a year according to Forbes and has a home in Beverly Hills, has signed a prenup with fiancé Kris Humphries, who earns only $3.2 million a year. Kim will be protected through the prenup; in the event of a divorce, she will keep everything she owns now in addition to any income she earns during the marriage.

For engaged couples whose wealth and income are already evenly split, there is still a case for a prenuptial agreement. The court system can be complicated and expensive. A couple that doesn’t discuss financial issues could have a harder time during a divorce. A prenup can smooth some of these difficulties and help both partners leave the marriage with most of their own wealth intact. While prenups have traditionally been instruments of the wealthy, the recession has affected many people’s approach to protecting their assets. More middle-class couples are considering prenups now.

Would you or did you consider a prenuptial agreement before getting married?

Photo: david_shankbone

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Reader Question: Invest $100,000 or Pay Off Mortgage

This article was written by Flexo in Debt Reduction, Investing. 35 comments.

To someone with debt, receiving an inheritance can feel like winning the lottery. Occasionally, an heir doesn’t realize money will be coming her way and hasn’t planned for the windfall or thought about her options. Even those who do plan often realize that contemplating options for managing a potential windfall is quite different from making decisions once that money is in hand. There is a tendency to have a riskier approach to managing money until the windfall arrives in the bank account. Often, preservation instincts kick in and prevent people from taking action.

Whether to use extra money to invest or pay off a mortgage is a common concern. Economists look at the numbers. If, after taxes, you can earn more in interest or appreciation by investing the funds than the amount of interest you’ll save by paying off a mortgage early, it is a better financial decision to invest rather than accelerate debt repayment. In its most simple approach, this ignores that the savings from paying off a mortgage early are guaranteed, and finding a rate that would beat the mortgage for investments could be very risky.

A Consumerism Commentary reader offered the following question:

I am a single 53-year-old female with a 13-year-old daughter still at home. My mother passed away recently and I inherited a little over one hundred thousand dollars. My mortgage payoff is $41,000 and I have a second that is $14,000. My Lutheran Brotherhood rep tells me to invest all of it and to not pay off my mortgage since I only have seven more years on the loan at 5% interest. My gut tells me that I should pay off my mortgages to be totally debt free. Any thoughts would be greatly appreciated.

Nothing beats finding and working with a trusted financial planner when handling these questions. Being debt free is obviously important to this reader. Paying off debt is a burden. Every month, the work you do generates income already designated for someone else. Debt may not be slavery, but you will never fully own your income and the work you do to create that income until you are free to do what you want with all of your (after-tax) income.

The representative may have positioned 5% as being a low interest rate. It’s not a terrible mortgage interest rate, and you might even be benefiting from the home mortgage interest tax deduction. With only seven more years left in the loan, however, the biggest tax benefit is behind you because the majority of each mortgage payment goes to the principal of the loan rather than interest.

Can you beat 5% by investing the $100,000? It’s possible, but not guaranteed. A Lutheran representative should be aware of the risks; recently, Thrivent Financial for Lutherans was one of a select number of organizations that lost almost all of its investments due to a risky and possibly fraudulent investment scheme at J.P. Morgan. A proper mix of simple stock and bond index funds could beat 5% in the long run, but performance over shorter periods of time, like a decade, could be worse than the 5% you’d achieve by paying off the mortgage.

Even if you use $100,000 to pay off the remaining mortgage balances, you’ll still have $45,000 left, so it’s not an all-or-nothing question. Going further, if you strongly feel that investing is a better way to secure your financial future but you also feel strongly about reducing debt, you might be more comfortable using the windfall to pay off half of your remaining mortgage balance, leaving a larger remainder to invest. This would give you the benefit of exposure to stocks for the long-term while greatly reducing your monthly mortgage obligations or allowing yourself to finish paying off the mortgage a few years earlier than expected. If your daughter is 13 now, she may move out in five years. That could be a good time to downsize your living arrangement to save money, and when that happens, you may feel more comfortable if your house were to be completely paid off by then.

One other thing to consider is whether the representative you spoke to is also representing an organization like Thrivent Financial for Lutherans. This is a non-profit organization designed to help the community of Lutherans succeed financially through prudent investing. Due to his affiliation, he would suggest investing. Not only is it an acceptable choice and probably not a terrible decision, but his affiliation with the organization would certainly sway his advice towards the benefits he can provide. If you walk to a car dealership an ask a salesperson, “Should I buy a car or pay off my mortgage?” you can expect the car salesperson to suggest buying a car — from him.

This question is open to anyone who would like to comment. Should this reader use a $100,000 inheritance to pay off the remaining $55,000 balance on the 5% mortgages or invest the entire windfall?

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How To Combine Finances for Couples

This article was written by Flexo in Family and Life, Featured. 10 comments.

When a couple marries or otherwise commits to be in a long-term relationship with each other, the question of whether to combine money usually arises. The debate about whether what could be called “his money” and “her money” should become “our money” is endless. Different arrangements work for different couples, and this article doesn’t address that question.

Those couples who do decide to combine finances often stop at the minimum. They might create a joint checking account for shared expenses like rent or mortgage payments but don’t make an effort to take co-ownership of the complete financial picture. I have not been in a situation that warranted a combination of finances, but I’ve given the issue some thought.

1. Agree on life goals. This isn’t necessarily a pure financial concept, but your money depends on what you want to do with your life. Being wealthy is not a goal because money is nothing but a tool to help you achieve accomplishments that are important to you.

It may be safe to assume that a successful relationship stems from agreement on world views and major life goals, but work out the details. For example, what will retirement look like? What is the philosophy about philanthropy? Will you leave an inheritance? Opening the communication about these larger issues, and finding compromises if necessary, enables a better decision-making process.

2. Combine basic spending and savings accounts. As mentioned above, this is usually the first and last step couples take. This is easy: open a joint checking account at your favorite bank. Even the question of whether each individual in the couple contributes the same dollar amount, the same percentage of income, or some combination, is one of the easiest questions you’ll have to consider when combining finances.

This step is easiest when each side of the couple produces roughly the same amount of income for the same amount of work. Perhaps a better way of looking at this question is considering how much each individual should keep for his or herself, making the shared account the default.

3. View investment portfolios as a whole. More difficult than an income disparity is a risk tolerance disparity. There could exist a couple wherein one individual is comfortable putting most of the family’s long-term wealth in the stock market for a better chance of growth over that period while the other would prefer the funds to be safe and less volatile. This couple will have a more difficult time finding a compromised solution.

My company offers tools to manage the risk of my 401(k) investments, but the facility of tools like these are limited. If my 401(k) was my sole investment, this automated questionnaire-based tool would be sufficient, but it takes neither my other investment accounts nor a theoretical spouse’s investments. Rather than relying on these tools, a couple should manage their risk in total and make sure they asset allocation and diversification is in line with goals and needs.

4. Work together to pay off debt. Like merged assets such as bank accounts, a committed relationship also turns “his debt” and “her debt” into “our debt.” It’s in the couple’s interest to pay off debt as quickly as possible. This can certainly not seem fair, particularly if one side of the couple worked diligently to pay off debt while the other slacked.

As long as trust, honesty, and open communication are a part of the relationship, there should be no surprises.

5. Everyone is involved. I’ve seen couples where one person handles the finances and the other prefers to have nothing to do with the details surrounding money. I understand that not everyone has an interest in personal finance, as much as I wouldn’t like to believe it because fewer people interested means fewer people reading Consumerism Commentary, and so I accept that not everyone wants to deal with the bits, bytes, cents and dollars. Each couple needs only one person in Quicken or Mint tracking finances with that level of detail. Perhaps some of the bill-paying duties, however, should be shared.

A business partnership is different than a life-long committed relationship. In a business, perhaps only one person handles the finances. In a couple, taking care of money is like taking care of children. Both will grow and develop best when everyone is involved.

How have you succeeded in combining your finances — and your life? If you have decided to keep your money separate, why was this the right choice for you? For everyone, combined or not, what obstacles have you encountered?

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How to Avoid Estate Taxes: It’s Easy This Year

This article was written by Flexo in Taxes. 8 comments.

In most years, only 0.3 percent of those who pass their estates to heirs upon their death end up leaving those heirs with a tax bill. Thanks to exceptions, credits, and thresholds, even the very wealthy can avoid the estate tax. This year is a special year, however. As of today and unless the law is changed, anyone who dies in 2010 is guaranteed to owe no federal estate taxes; this tax has been repealed for just this year.

Last year I considered whether this one-year break would encourage families to keep their loved ones on life support until January 1, 2010 or to encourage passing before January 1, 2011. I wasn’t the only one. A study from Columbia University found the following based on data from other estate tax law changes throughout the last century:

There is abundant evidence that some people will themselves to survive in order to live through a momentous event. Evidence from estate-tax returns suggests that some people will themselves to survive a bit longer if it will enrich their heirs. To be sure, the evidence is not overwhelming. Nevertheless, our central estimate is that, for individuals dying within two weeks of a tax reform, a $10,000 potential tax saving (using 2000 dollars) increases the probability of dying in the lower-tax regime by 1.6%. That there is any effect at all adds to the large body of evidence that taxes affect behavior, and particularly the timing of behavior, including activities such as marriage and childbearing, which are not generally thought to respond to financial incentives.

We cannot rule out that what we have uncovered is not a real death elasticity, but instead ex post doctoring of the reported date of death to save on taxes. Even in that case, this exercise provides evidence on how the attempt to collect taxes can engender resource-using avoidance responses that reduce tax revenue.

Changes in the law encourage people either to optimize time of death or to report death at the optimal time. This may not be the case for Dan L. Duncan, the first billionaire whose heirs will owe no estate taxes on their inheritance. Because Congress didn’t close this one-year reprieve, the Treasury stands to miss billions of dollars in income, some from Dan and some from other very wealthy individuals, that would have otherwise been collected.

Some charities and other non-profit organizations may feel a side-effect from this year’s exemption. Charitable giving is often a part of estate planning, and one goal of estate planning is to reduce tax liability. Charity has the benefit of being a good deed and sheltering wealth from taxes. If there are no estate taxes to avoid this year, there will certainly be estate planners who decide to pass all income to heirs rather than distributing wealth to needy organizations.

Legacy for One Billionaire: Death, but No Taxes, David Kocieniewski, New York Times, June 8, 2010

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The Wrong Reason to Dollar-Cost Average

by Pop

Pop writes about the intersection of our lives and economics at Pop Economics. There, you can find biweekly posts on everything from how your behavior affects your personal finance decisions to what the Fed’s most recent move means to you — not to mention some killer pop art. He recently wrote: Resistance is futile: Why ... Continue reading this article…

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In Detail: How to Claim the New Home Buyer Tax Credit on 2009 Tax Returns

by Flexo

In November of last year, President Obama and Congress expanded the home buyer tax credit to cover more people who have purchased houses in 2009 and 2010 and to further stimulate the real estate industry. Earlier this month, the IRS released an updated tax form to include the new rules. If you want to claim ... Continue reading this article…

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Help a Reader Who Inherited $10,000

by Flexo

Does anyone have advice for Sibyl? She commented on an article reviewing Jane Bryant Quinn’s latest book with a question pertaining to her own finances. Sibyl was kind enough to include many details about her family’s finances. I have some suggestions, but this is always a good opportunity to have readers provide theirs as well. ... Continue reading this article…

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Am I Required to Report All Income to the IRS?

by Flexo

In general, if you have to ask whether you need to report certain income to the IRS, the most likely answer is, “Yes.” Here are some examples, courtesy of MSN Money. Q. I hosted a party to sell products to my friends (and use my social circle for multilevel marketing from some corporation), and the ... Continue reading this article…

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