Mrs YFG and I had the immense pleasure of attending our friends’ wedding this weekend past. It was a lovely occasion. And it got me thinking about divorce.
It’s unlikely Mrs YFG and I would get divorced. She is far more like to kill me instead (she’s probably already started slowly poisoning me as I write this).
Late last year I heard about Mr and Mrs Money Mustache getting a divorce. It was very sad to hear. At the turn of the year, Mr Money Mustache wrote a candid and heartfelt post about the experience. What struck me most was the positivity he had despite going through such a traumatic event. He had the chance to take a “woe me” attitude. But instead took the opportunity to reflect on a life lived and yet to be lived. I’m very grateful he took the high road.
The economics of divorce
MMM titled his post the ‘Economics of Divorce’. Though I must say, there wasn’t much about money in the post! Except that Mr and Mrs MMM took a low-cost collaborative approach (very wise!). As a young chap in the early days of marriage, I don’t have a great deal of ‘advice’ to dish out.
However, one aspect of my old job was literally the economics of divorce. So I thought I’d take this opportunity to explain some of the financial principles around divorce and dispel some misconceptions. But just before I do, I should point out I’m not a lawyer – so this ain’t legal advice – and I’m writing about English and Welsh law (I don’t know how it works in other places).
I’m a forensic accountant/valuer by trade. One of the major bits of work for lots of forensic accountants is ‘Matrimonial Disputes’. That is, couples get a divorce and argue about the finances. Sadly, this is quite common. Lawyers will get in touch with a forensic accountant to work out what money is where and what the value of the assets are.
I’d go about valuing any businesses the spouses may own as well as understanding the total financial resources of the couple and where they lie. Sometimes, the ‘wealthier’ spouse is suddenly destitute. I’d be tasked with finding out what happened. Did they siphon off assets offshore? Or were they secretly doing bad deals that blew up their finances?
The starting point
With the background out-of-the-way, let’s start talking about money. One of the things I often see in media reporting is the conflation between Assets and Income (maintenance). This is very important as they are distinct and treated very differently.
Assets are the capital that the couple collectively owns. These are things like property, business interests and pensions (handsomeness doesn’t count unfortunately for me).
For our purposes, there are two types of assets. Matrimonial and Non-Matrimonial. Matrimonial assets are the assets bought by either or both spouses during the marriage. The principal matrimonial asset is often the family home. What is and isn’t a matrimonial asset is often complicated. But generally speaking, an asset purchased with marital property will be classed as matrimonial property.
This is where people often get a little upset: “My ex-spouse is kicking me out of my home. I bought it with my hard-earned money.”
For example, take a single income couple. The income is marital property as it funds the marriage. If that income is used to pay for the mortgage or the upkeep of the family home then it is very likely the home also be matrimonial property.
Take another example, an individual owns a company that pays a salary and dividends. If they use that income to pay for the living costs of the marriage, some element of the company will likely be considered a matrimonial asset. In other words, you can’t use an asset to fund your marriage then say it’s not a matrimonial asset (the ol’ have your cake and eat it strategy).
The ‘breadwinner’ and child carer/homemaker are considered of equal value to the welfare of the family. As such, the matrimonial assets are typically added up and split 50:50 between the spouses. We’ll come to some exceptions to this in a bit.
Pre or post-marriage assets
A key element in valuing the assets is whether it was a pre or post marriage asset. Let’s take the example of the business owner. Say they set up the business pre-marriage and it was worth £1m when they got married. On separation, the company is worth £2m. The matrimonial asset is £1m (£2m minus £1m), the non-owning spouse will receive £500k, 25% of the overall assets (we’ll get to some complications with this in a bit).
Some assets that exist pre-marriage may not become matrimonial assets. This is particularly relevant for someone with a family trust fund. As I mentioned above, whether something is or isn’t a matrimonial asset can be complicated. But if we take the trust fund as an example. Assets set up pre-marriage and left completely untouched during the marriage (i.e. any income or capital from it wasn’t used during the marriage) will probably not be considered a matrimonial asset (Note: I’m not a family law expert).
One way to protect pre-marital assets is through prenuptial agreements. Unlike in the US, these are not legally binding (sorry Kanye). But following a Supreme Court case a few years ago, they must be considered by the court. For example, you may sign an agreement with your future spouse that if you were to ever split up, you would first get the capital put into the family home and share any excess equity.
These types of agreements will often stand up in court. Judges are reluctant to place their own interpretations of the spouses thinking on these agreements. That said, they should be adhered to. A court may look less favourably on a prenuptial agreement if the spouse later remortgages the home to pump money into their business which in turn funds the individual’s life at the expense of any children.
This is one big misconception I saw. A partner would put all the capital into the house. But at the same time refuse to acknowledge they then used that capital to fund their business or personal interests. (again the ol’ have your cake and eat it).
Where it gets a bit more complicated
I mentioned above that it gets more complicated in a few places. Let me talk about two of these complications: the ‘special contribution’ and the ‘springboard’.
The special contribution
Earlier on I said that the starting point for sharing assets is 50:50. That can be deviated from based on the needs of the individuals (these are set out in the Matrimonial Causes Act 1973). One of these deviations is where one of the spouses has made a ‘special contribution‘ to the marriage.
In effect, it’s where the court judges that it would be unreasonable to split the assets in half because one spouse made an exceptional contribution to the matrimonial assets. This argument has been put forward a number of times and rejected almost as many. One particular example where it was accepted was in the divorce of Sir Chris Hohn (a famous hedge fund manager). He successfully argued that his contribution was indeed special and that he should get more than 50% of the assets (he received 64%). The judge specifically referred to his “financial genius in his particular field of financial investment” (he is, after all, one of the most successful hedge fund managers/philanthropists of all time). The line has lead to the special contribution being called ‘the genius test’. Which is unfortunate for everyone who is deemed ‘bog standard’.
Others have tried to put forward the ‘genius’ argument and have failed. The court is typically reluctant to discount the other spouse’s role in the marriage (homemaking, raising children and supporting the other spouse in their career).
Earlier on I did some fag pack maths to work out the matrimonial assets. At it’s simplest it is: Value of assets at separation less value of assets at marriage. But it’s more complicated than that. Due to the springboard.
The springboard is the principle that it would be unfair to take the value of the assets at marriage because it doesn’t reflect the impact of external events on the value of the assets. For example, the effects of economic growth over 20 years would significantly increase the value of many businesses even if it was frozen in time.
The springboard dates back to a case where a gentleman owned a very successful oil and gas company. He met and married (his also wealthy) wife and they were married for almost 10 years. The husband’s business was worth £2m at the date of the marriage and had increased in value to £12m on separation. It was then finally sold for a net profit of £25m.
The husband successfully argued that the starting point shouldn’t be £2m. Instead, the business had ‘latent potential’ that should be reflected in any value used. The court decided that instead, an offer to buy the business a year after marriage for £6-7m reflected some of that potential. In addition, economic growth (the boom in the industry) should also be factored in. Thus the value used was increased to £9m (rather than £2m). The wife received £8m (£25m-£9m = £16m / 2); 50% of the matrimonial assets and 32% of the overall assets.
From a professional point of view, the challenge with the springboard is that it can potentially contradict the concept of using market values. Ignoring the prevailing market value of an asset is something that shouldn’t be taken lightly.
That’s assets dealt with. Now the income, or maintenance side. There are broadly two types: spousal and child maintenance. The first is the maintenance of the spouse’s standard of living, the later the standard of living of children from the marriage.
The principle behind maintenance is that it is the money required to maintain the standard of living the spouse and child had during the marriage. The law in effect says you can’t have your spouse living in a four bed detached house and your child going to private school and then once you’ve dumped them expect them to live in a bedsit above a kebab shop. It’s of course, as always, a bit more complicated than that, but hopefully, you get the gist.
This is usually a regular payment made by a spouse to their ex. It’s paid only where the ex can’t support themselves financially without it. Financially means the level of financial well-being they had during the marriage. The amount depends on how much they need to live on (to maintain that lifestyle), how much they already have (capital, see above, and their own income) and how much they can earn in the future.
The last point is very important. The court will take into consideration whether a spouse gave up their career (and therefore sacrificed their future earnings) for the marriage. It’s sadly too common to see a spouse who has run off with a young 21-year-old Brazilian model (I’m still hopeful) who expects their spouse to ‘go back to work’ after 20 years out of labour force. Completely forgetting the contribution they made to the marital home.
Where a couple has been together for a long time or unable to go back to work, it can be paid for life. That said, the courts have become more reluctant to offer life-long maintenance and expect spouses to make reasonable adjustments to their living costs (it’s reasonable to expect you to switch out the Dom Perignon for Moet).
Likewise, it’d be considered somewhat unreasonable to pull Tarquin Jr from Eton and send him to the local comp. Therefore, the spouses are expected to financially provide for their child’s future needs.
Sometimes, spouses seek a clean break. Instead of maintenance payments, a lump sum is paid and the parties can go their separate ways.
I thought I’d end with a few tips. Please don’t take these as legal advice (I’m not a lawyer).
- Strongly consider mediation. This is where you, your lawyers and your spouse’s lawyers sit down together and discuss what you want. It can be even be chaired by an ex-judge, QC, senior lawyers, counsellors or other very wise people. It’s often much cheaper (often over 50% cheaper). Finally, it is an excellent way to talk in a structured and safe environment and express, without fear, what you want. Sometimes, what might appear irrational demands, become rational when they are said through mediation: “My ex-spouse wants to take me to cleaners” is often: “My ex-spouse is scared that I will bugger off and leave me a single parent and my child without the financial and emotional support to have a successful upbringing.” (Some links for further reading: Family Mediation Counsel; Centre for Effective Dispute Resolution; ADR Group; Civil Mediation Council).
- Try to reach a negotiated settlement. I used to say this to clients because with a negotiated settlement you at least agree to it. If you go to court, somebody else will decide what you get and you don’t get a choice of agreeing with it or not. Sometimes the psychological aspect of having an agreement that you reached through choice can be better than a potentially bigger ‘payout’ that you didn’t agree to.
- Lawyers have a bad rep (I know, I married one), but good lawyers are worth it. They are there to fight your corner and support you. They’ll look out for you and seek out your best interests. They aren’t just there to ‘fight battles’ and be attack dogs. Legal disputes can be very scary. Having an expert professional to help guide you through the rough patch can be immensely helpful.
- Don’t overreact. Many times I’d get unreasonable emails come through from ‘the other side’. Never get into a slanging match or respond when angry. Keep cool and take your time. Don’t rush. For the most egregious correspondence, wait till the morning after to deal with it. Unreasonable behaviour reflects poorly on the other person – not on you.
- Don’t get worked up about ‘blame’. We have a bizarre thing in England where you have to have a ‘reason’ for a divorce. In effect, this becomes what can you blame the other person for doing (we’re hardly gonna blame our perfect selves). Don’t take the ‘blame game’ personally. It’s a relic of a bygone era and hopefully, the government will get rid of it soon.
That’s all from me.
All the best,
Young FI Guy
P.S. To my embarrassment, last weekend Monevator linked to an FT article about the decline in life long maintenance (as mentioned above). Please do not read the comments to the FT article.