Jacqueline B. Gold, CDP, Center for Financial Planning, Inc.
Contributing Writer: Marie A. Pulte, Esq., Law Offices of Marie A. Pulte, PC
Michigan Family Law Journal, 2003
The Financial Impact of Divorce on Children
Every divorce practitioner knows the statistics. Over 1.2 million divorces are filed in the United States each year. As a result, 2.4 million adults each year have to grapple with the emotional and financial ramifications of divorce. However, the often-overlooked third parties to a divorce are the children whose lives are forever emotionally and financially impacted by the decisions and agreements their parents make during this stressful time. When children's financial needs are not met as a result of a divorce, it causes tremendous emotional stress that can have a rippling effect on the child's future development and outlook on life, as well as their relationship with one or both parents. On the other hand, in situations where their financial wants and needs are considered, the emotional distress for children can be minimized and even in some cases, bypassed altogether.
Child Support
When considering the financial impact of divorce on children, the first and perhaps most obvious aspect to consider is child support per the Michigan Child Support Formula Manual (commonly referred to as the "Guidelines"). In Michigan, the child support formula is based primarily on the income of each parent, the number of children involved and the custody arrangement. Other issues related to child support are also addressed, such as daycare costs and uninsured medical expenses for the children. In Michigan, there is a significant reduction that occurs in child support if the non-custodial parent has more than 128 overnights with the children.1 As can be well imagined, this section of the law sets parents up to place a financial spin on parenting time that can potentially negatively impact the child's relationship with one or both parents. In many cases parents argue over parenting time for the sole purpose of increasing or decreasing the child support. There is a built-in incentive for the non-custodial parent to argue for more than 128 overnights so the support will be lower and there is also a corresponding incentive for the custodial parent to argue against the children spending more time with the parent so the support will be higher.
Unfortunately, neither of the positions above focuses on the best interest of the child. As such, with the current state of the law, it is important for attorneys to encourage their clients to keep the children's best interest in mind rather than personal financial incentives. When a final settlement is reached, if the parenting schedule is not what the client truly believes is going to occur, it's helpful for clients to maintain a calendar of the actual time spent with the other parent so that the child support formula can be revisited at a later date.
What Child Support Does Not Cover
As detailed above, child support in Michigan (like every state) is based on a formula mandated by the state. According to the state and federal statutes, which dictated the formula's development, the formula was to "be based upon the needs of the child and the actual resources of each parent." MCL552.519 (3)(a)(vi), MSA 25.176 (19)(3)(a)(vi), 42USC 667 (467)(a). What many parents do not realize is that child support does not take into consideration all of the actual expenses of the child or the age of the child. The costs associated with a six- or seven-year-old are dramatically different than the costs related to a teenager.
Over the years, I have had many clients whose children's non-basic needs were extremely important to them and the uncertainty regarding their ability to continue to pay the related expenses posed a barrier to settling the case. A sample of these expenses have included private school tuition, camp costs, college funding, lessons, school trips and events, tutoring for special needs children and care for adult children who were disabled.
Unfortunately, children, as well as adults, are often negatively impacted when their needs are simply overlooked or ignored in the divorce process. The reality is that when a divorce occurs, there will be a reduction in the standard of living for both parents. Usually, it is impossible to maintain the same financial standards of living while managing two households with the same income(s) formerly used to run one. Even if it is determined that the feasibility of paying for some of the above-mentioned costs is impossible, it is still better for all involved to discuss these issues while the divorce is pending and to make a determination at that point.
As an example, consider Lisa, whose nine-year-old daughter, Susan, was in training to become an ice skater. While the parties were married, Susan's instruction had been a priority to both parents and considerable sums of money had been spent on training costs, costumes and competition fees. Lisa assumed that the continued (accelerating) cost of skating would be taken into consideration in the child support award, as this had been an integral part of Susan's rearing. Lisa wanted to lessen the already painful affect that the divorce would have on Susan by disrupting her activities as little as possible. Lisa's attorney had the unfortunate job of explaining to her that extracurricular activities was not a factor in traditional child support and, if Susan's training would continue to be a priority, we needed to creatively determine what other sources of income might be used to fund the ice skating costs.
Feasibility of Extracurriculars
The first step in determining if the added costs of skating, private school tuition, etc. can be maintained, is to create a detailed list of the total annual cost and then build in an inflation factor. In Lisa's case, we reviewed her old checkbook registers and compiled an inventory of every cost associated with Susan's skating for the last several years. This was a good way for us to determine at what rate the costs were going up each year for use in running future projections. She also had several discussions with other parents of older skaters to help determine what future costs may be incurred, as Susan got older.
The second step was to factor into the equation all of Lisa's potential sources of income. These included non-taxable child support income, (based on the Guidelines), her net income from her employment, investment earnings and several ranges of potential net spousal support awards. Then, we determined a "guesstimate" of what her income would be after taxes, taking into consideration her potential itemized deductions, earned income credit and exemptions. Next we calculated 20-year cash flow projections for Lisa to determine what her net deficit would be, after taking into consideration all of her potential net income and deducting off all of her living expenses, as well as Susan's skating costs. We arrived at a $5,000 annual deficit in the first year.
After showing these spreadsheets to her husband, "Jack," Lisa asked him how he would like to handle Susan's future skating costs. After reviewing the spreadsheets, "Jack" agreed that he, too, wanted Susan to continue skating and would be willing to share all of the costs related to it on a 50/50 basis. This was incorporated into their settlement agreement; thus, creating an agreement that considered Lisa's needs and went far beyond the scope of basic child support.
Parents can always consent to sharing such expenses by adding a specific provision to their Judgment of Divorce, or by adding the child support payer's share of the additional expenses, directly into the weekly child support payment. However, in order to deviate from the child support amount dictated by the formula the court must make specific findings, whether the deviation is by consent or by decision of the court.2
The end result in Lisa's case is that she had the peace of mind knowing that she could afford Susan's skating expenses without worrying about being able to pay her mortgage. In addition, "Jack" didn't feel that the entire financial burden (and resulting resentment from Susan if she couldn't continue) would be on his shoulders.
Even if the parties had determined that Susan would not be able to continue skating based on their future financial obligations and needs, they could explain to her that they had done their best to consider her wants and needs and determined it was more important for mom and dad to both provide her with a stable financial home. I highly recommend to parents that they go through an exercise such as this, either with a financial planner or on their own to determine what will (and will not) be affordable for their children after the divorce.
Child Support Arrearages
Often times, when there is a child support arrearage, the custodial parent feels at a loss as to how to recoup the money. An often overlooked means of recouping the past due support is the use of a QDRO (Qualified Domestic Relations Order) to divide a retirement plan. Essentially, the child can tap into an otherwise inaccessible asset prior to the non-custodial parent's retirement without penalty. According to ERISA (Employee Retirement Income Security Act), Section 206(d), an alternate payee can be a spouse, former spouse, child or other dependent of a participant.
For example, let us suppose that the payer of child support is in arrears by a total of $30,000. Let us also assume that the payer has a 401(k) through his employer with $120,000 account balance. A QDRO can be drafted, pursuant to an order of the court that awards the child $30,000 from the 401(k) plan. After the QDRO is submitted to the court and approved by the Plan Administrator, the money would be immediately distributed to the child's guardian. An important aspect of this is that money would not be treated as a taxable distribution to the recipient-child, but rather would be treated as a taxable distribution to the participant-payer. Remember that when funds are distributed via a QDRO to an alternate payee who is a spouse or former spouse, the money is treated as a taxable distribution (if not rolled over into an IRA) to the alternate payee. However, when a QDRO is used to obtain money for a child, the distribution becomes taxable to the participant.
It is also possible to draft a QDRO on a defined benefit plan (which provides a lifetime stream of income to the participant) for the benefit of a child to collect child support arrearages. If the plan is already in pay status (in other words, if the participant is retired), a monthly amount for a certain period of time can be easily assigned. Using the example above, let us assume that there is no defined contribution plan but that the participant is retired and receives retirement income of $2,000 per month. A court order could be entered granting $500 per month to the child for a period of 60 months until the arrearage is paid off. It would also be possible to assign a portion of a pension that is not in pay status; however, the money would not be distributable to the alternate payee (in this case, the child) until the participant attained the earliest retirement age under the plan.
College Costs
Another important issue that is typically overlooked in Michigan divorce cases is the cost of college for children. Yet, it's a rare case (when there are minor children) in which one or both parents is not extremely concerned about whether or not their children can still attend college. In fact, although Michigan does not currently have a college provision in it's child support formula, that is not the case in numerous other states. As many attorneys have experienced, often a case cannot be settled expeditiously, because a client insists on incorporating college for the children into the settlement. While this cannot be accomplished through child support (unless both parties agree to deviate from the Child Support Guidelines), there are other means of earmarking money today for future college costs.
Determining Future College Costs
The average cost of a college education (ranging between $12,000 and $40,000 per year depending on the school) is astronomical and is increasing at a rapid rate.
It is important to understand that in order to qualify for most federal student loans, the income of both parents will be considered. Therefore, if one parent has a large income and refuses to pay for college, the government still views that child as having the ability to pay for college without financial aid.
The first step for parents is to add up what money is already set aside for the children in Uniform Transfers to Minors Act (UTMA) accounts, Section 529 Plans or MET (Michigan Education Trust) contracts or Irrevocable Trusts (such as Clifford Trusts). After this money is considered, a simple projection can be run by a financial advisor or can be easily obtained through various Internet websites, which incorporate existing funds (and an assumed rate of return on those funds), current college costs, and an anticipated inflation factor. These projections will illustrate how much money is needed today (in addition to what is already set aside), in order to provide for four years (or more if desired) of college costs for each child.
The next issue is determining what vehicle is best to put the money into. There are many options available (and all should be discussed with an advisor). However, one of the most attractive options today is an IRS Section 529 plan. These plans are attractive because unlike the MET contract, the money can be used for a college in any state (versus just Michigan) and the money can be transferred from one child to another.
Again, it is important to "dot as many i's" and "cross as many t's" as possible before the divorce is finalized. In other words, the more loose ends that are left hanging once the judgment has been signed, the more likely that the best intentions will go by the wayside. If this is what the parents agree to, it is important to obtain all the paperwork and fill out the forms before the divorce is finalized.
As a word of caution, it is also often helpful to the parties, to have a financial advisor run future projections that incorporate various assumptions regarding their future incomes, expenses, etc. These projections give the parties information needed to determine whether they can really afford to set the money aside and how their financial future is likely to look, given this commitment. Of course, financial projections are never a guarantee of outcomes, but they can offer some insight into potential implications of setting aside money today. Often times, this type of decision is based on emotion and one or both parents cannot really afford to make a large financial commitment to college. The future projections can provide a reality check in such a case, where parties are not being reasonable regarding finances.
In addition, keep in mind that money gifted to the children becomes their legal property to do with as they choose. In the case of an UTMA account, the gift made to the child is irrevocable and accessible by the child upon their attainment of age 18. Divorcing parents need to consider what will happen to the money if the child doesn't go to college or chooses to use the money for another purpose than what was intended at the time of the divorce. The type of investment vehicle chosen can impact the irrevocability of the money earmarked for college costs.
Making the Children a Priority
In conclusion, every step possible should be taken by parents and their attorneys to keep the financial concerns of children in mind when creating divorce settlements. It is at this critical juncture that the children need the most reassurance, security and protection. When children are completely overlooked with respect to a financial settlement, they may not only be affected monetarily, but the relationships between their parents and siblings may be negatively impacted for years to come. However, when children's needs are considered during the divorce process, future potential problems maybe avoided altogether.
Endnotes
- ***The Supreme Court Administrator's Office, (SCAO), is currently conducting a federally mandated evaluation of the Michigan Child Support Formula Manual and the shared economic responsibility formula. No significant changes have been made in the way that child support is determined and in the way the "guidelines" have been used since the inception of their use in the late 1980s. Some believe, including the State Bar of Michigan Family Law Council committee, which was formed to study this issue, that the underlying data, from which the present guidelines were constructed, may have been flawed from the beginning and bore no direct reflection of child support costs in the state of Michigan. Further, they believe that the present organization, Policy Studies, Inc., (PSI), retained by the SCAO, to evaluate these issues, should be replaced with an independent research group, inasmuch as PSI developed the guidelines to begin with. Lastly, that the cliff effect involving a dramatic reduction in child support after 128 overnights, should be replaced with a more equitable method of apportioning children's costs between parents sharing custody. There have been several suggestions made by members of the Friend of the Court Advisory Committee, which have involved a more gradual decline in child support starting with 105 overnights although some believe their final report may recommend that the reduction start at even less overnights. It is unknown what the SCAO will do, although it is believed they will make a decision sometime this fall.
- In order for the court to deviate it must find that the application of the formula would be "unjust or inappropriate" given the facts of the case. In doing so, the court must address all of the following either in writing or on the record: "(a) The support amount determined by application of the child support formula, (b) How the support order deviates from the child support formula, (c) The value of property or other support awarded in lieu of the payment of child support, if applicable, (d) The reasons why application of the child support formula would be unjust or inappropriate in the case. Michigan Child Support Formula Manual (2001), p1. See also, Ghidotti v Barber, 459 Mich 189 (1998), Burba v Burba, 461 Mich 637 (2000).