01 Aug Key Ways Inflation Impacts Your Divorce
Over the last six months, you have likely heard the word “inflation” more often in the news, in conversations with others, and as an explanation for rising costs in almost all aspects of life. If you are going through a divorce alongside these market dynamics, you will be impacted by inflation.
Simply put, if you expect to receive maintenance in your divorce, you are at a higher risk of feeling the effects of inflation because the fixed value of that maintenance won’t go as far to pay for rising expenses. These dynamics aren’t unique to high-inflation times, but are felt more during turbulent financial times. In fact, an individual receiving maintenance will always have significant exposure to inflation risk, especially if they are unemployed. This is because most of the time, the maintenance received doesn’t change during the life of the award (assuming the award is never modified), while costs continue to rise over time.
This reality can be deceiving if you don’t understand the effects of inflation, especially on a long-term maintenance award. Even during times of normal inflation (2.5%) an award is eroding by inflation. The current environment (which is closer to 8%-9%), could wreak havoc on a maintenance award. Whatever the level of inflation, it erodes the purchasing power of a maintenance award and individuals receiving maintenance should be aware and plan accordingly.
In this post, we outline key considerations, questions, and strategies to address inflation in your divorce.
The effects of inflation
The effects of inflation are felt immediately when you start to receive maintenance. Consider inflation like an income tax that doesn’t require a tax return filing or a mandatory tax withholding from a retirement account withdrawal that was not expected. Imagine that, instead of receiving a $20,000 withdrawal that you requested you only receive $16,000 because the difference was withheld for taxes. In other words, divorce can be challenging to navigate because not only do most divorcees experience many unforeseen expenses that pile up such as health insurance and car payments, you are automatically starting from a more cash-strapped wallet due to inflation.
These dynamics are unique to those who receive maintenance because wage earners don’t have inflation risks to the same degree as an unemployed person. An employed person’s earnings can grow over time through cost-of-living raises. If you are retired or not planning to re-enter the workforce, you will feel inflation to a greater degree.
Ask the right questions
There are several things to keep in mind to address inflation in your divorce. These are great questions to discuss with a financial expert or dedicated financial resource. The answers to these questions can help you successfully negotiate a possible maintenance award and/or the division of assets in your divorce as well as protect your financial future.
- What other assets are you receiving from the divorce?
- Understanding whether these assets can grow and counterbalance some of the dynamics of inflation will help you make decisions about the division of assets in your divorce.
- Are the assets available if needed and can I rely upon them with minimal taxes and penalties?
- Understand the liquidity constraints of your assets and whether selling them results in tax consequences.
- At what rate will the assets grow? Will they keep up with inflation?
- Property and stocks may grow quickly whereas other assets may not appreciate at the same rate or may have higher expenses associated with them. Understanding how assets grow and modeling their potential is an important step in planning your divorce and planning your future.
- How much margin have you built into your future budget?
- Knowing how much flexibility you have if inflation worsens and how much risk you can absorb can help you navigate future budget expectations.
- Will you need to plan on downsizing your living arrangements and lifestyle while retaining growth assets as much as possible?
- Modeling whether you have enough diversity in your portfolio to weather the storm of inflation (including property, stocks, 401(k) accounts, cash, and more) can give you peace of mind about your financial future.
- Have you made future employment plans to address your needs if necessary?
- Depending on the financial dynamics of your divorce, you may consider re-entering the workforce to earn income that can supplement the impact of inflation.
Strategies to manage inflation
There are things you can include in your divorce agreements to protect yourself from the effects of inflation. For example, some individuals and attorneys are requesting and advocating for a cost of living provision or adjustment in their maintenance awards. This essentially recalculates the maintenance award annually based upon the current Consumer Price Index.
Another approach involves balancing assets that will likely increase in value over time with aspects of your maintenance award that will decrease in value over time, in your divorce negotiations. Keep in mind that inflation can also raise the value of the things you own, including the value of your home and stocks. Include these assets in your portfolio with those that might have a more increased probability of losing value in the future due to inflation.
If the marital estate has enough assets to do so, you can even consider a lump sum maintenance award that can be invested and grow, which can lessen the risk of inflation while improving liquidity. However, investment risks must also be controlled and balanced so working with a CDFA or financial advisor is crucial to understanding whether this is the right approach for you.
Working with a financial expert to help you understand the impact of inflation is necessary to address the confusing and complex market dynamic of inflation. At A.M. Financial, we offer financial modeling, planning services, and consultative expertise to support your decisions in divorce, including decisions regarding the division of assets.
Divorce transition/financial planning services offered by A.M. Financial. Investment advisory services offered through WealthSource Partners, LLC (“WSP”). A.M. Financial and WSP are independent and unaffiliated entities. The statements and opinions expressed are those of A.M. Financial and Amy Mahlen and do not necessarily represent the views and/or opinions of WSP or any other associated or affiliated person of WSP. Furthermore, the statements and opinions expressed are for informational and educational purposes only and should not be construed as legal, tax, accounting or investment advice. All statements and opinions are current only as of the time made and are subject to change without notice.