Impact of Market Volatility on Divorce Agreements

Following more than a year of stock market euphoria, February 2018 is thus far a month serving as a harsh reminder of the concept of market volatility. For spouses contemplating or in the midst of a divorce, the takeaway transcends mere numbers on a balance sheet.

In divorce cases, litigants have the option to take their case to trial or reach a settlement agreement. When litigants opt for the latter, their rights and obligations concerning issues of property allocation, spousal and child support, and the like are outlined in a Marital Settlement Agreement (“MSA”). The Illinois Marriage and Dissolution of Marriage Act (“IMDMA”) vests courts with the discretion to value assets and liabilities for purposes of property division as of the date of trial, or such other date as agreed upon by the parties or order by the court. 750 ILCS 5/503(f). Generally speaking, when litigants reach a settlement of their case, they use the date of divorce or one very close thereto as a valuation date.

Allocating Pro Rata Marketing Gains and Losses

For better or worse, the value of investment, retirement, and other assets consisting of securities is subject to change with virtually each passing minute. With many investment and retirement asset allocation, the physical transfer of funds generally does not happen within minutes, hours, or in some cases, even days of the finalization of a divorce case. Thus, where investment or retirement assets are not split equally between the litigants, it is crucial to account for and allocate market gains and losses in the time period between divorce and the execution of allocation.

To divide a qualified retirement plan (e.g. 401(k), 403(b), SEP-IRA, Traditional IRA), the Court must enter a Qualified Domestic Relations Order (“QDRO”) directing the plan administrator to effectuate the transfer of funds from the plan participant (employee) to the alternate payee (non-employee). With some plans, it may take at least 30 to 60 days from the date of divorce to process a QDRO and complete the transfer of funds from one spouse to the other. To put this time period in perspective, on January 17, 2018, the Dow Jones Industrial Average (“DJIA”) closed at 26,115.65. Approximately 30 days later, the DJIA closed 24,893.49—a swing of over 1,222 points or almost 5%. In the first several days of February alone, the market entered a correction (defined as a decline of 10% of greater).

Where spouses divide retirement and investment assets equally, they inherently share in the market gains and losses from the date of divorce until the date of an asset’s actual division or transfer. However, some cases and circumstances require one spouse being allocated a greater share of these assets, which is when it is crucial to include language allocating market gains and losses in pro rata shares. For example, while a vast majority of market analysts agree that timing the market is nearly impossible, a litigant being allocated 75% of a 401(k) will in periods of steady market growth want to ensure he or she receives their pro rata share of market gains. Similarly, with recent market volatility, a spouse being allocated 25% of a 401(k) will want to absorb only his or her ratable share of market losses.

Tax Consequences of Investment Asset Allocation

In addition, periods of market volatility stand to impact capital gains and losses generated from investment assets. The former can create a tax liability (e.g. where a holding is sold for more than its purchase price), whereas generally speaking the latter results in an asset (e.g. where a stock’s sales price is less than its purchase price, thus creating an offset against present or future capital gains).

Section 503(d)(12) of the IMDMA directs Courts to consider the tax consequences of property division. In high net worth divorce cases often involving millions of dollars of investment assets subject to substantial market gains and losses, it is important in periods of market volatility to recognize that certain holdings may carry positive or negative tax consequences to the litigants. In these circumstances, it is good practice to consult with financial advisors and accountants at even this micro level of asset allocation to ensure that assets and liabilities are being apportioned and allocated as the litigants contemplated, and to avoid an unintended result of one spouse being allocated a vastly disproportionate share of capital gains or losses.

As with all things, the devil is in the details.

 

This entry was posted in Divorce, Financial Planning, In the News, Retirement Benefits and tagged , , .
Brett M. Buckley

About Brett M. Buckley

An associate attorney with Schiller DuCanto & Fleck LLP, Mr. Buckley represents business owners, executives, professionals, celebrities, professional athletes, people with multigenerational wealth and their spouses in divorce and custody disputes, as well as in the preparation of premarital and post-nuptial agreements. Beginning as a law clerk with the firm in 2011 and as an associate attorney in 2013, Mr. Buckley concentrates his practice exclusively in the area of family law, including the distribution of multi-million dollar estates and complicated custody disputes.

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