When couples want to part ways, they may opt for a legal separation instead of directly going for a divorce, something most states allow. Couples may decide to first separate legally for religious reasons, or because of health-care coverage, Social Security or military family benefits among other things.
But the move can leave spouses financially intertwined and exposed. When legally separating, couples can split certain assets, such as nonretirement and bank accounts, but there are additional complications that must be considered. And they should ideally be addressed with a financial and legal expert. Among the potential issues:
You can’t split IRAs. Retirement assets such as IRA accounts cannot be divided upon legal separation. According to the Internal Revenue Service, IRA assets can be split upon separation if the marital settlement agreement is incident to the decree of divorce. In other words, there must be intent to divorce, although the time-frame given by the IRS is unclear.
If you divide the IRA, the IRS could rule that the funds that left the original taxpayer’s IRA be recognized as taxable income to the original IRA owner. Additionally, you run the risk of triggering an early IRA distribution if you are under age 59 1/2. The IRA funds that are distributed could be subject to ordinary income tax, as well as a steep 10% penalty. This could be a particularly thorny issue when couples have significant disparities between the values in their separate IRAs.
You may be liable for any of your spouse’s debts and legal issues. If you separate, you may remain liable for any of your spouse’s debts and any legal issues that arise. Creditors many come after one spouse if the other spouse uses, say, a still-joint credit card to run up debt. As a divorce financial strategist, I recommend that couples have a legally binding separation agreement that specifically addresses marital debt as well as any new debt incurred during the separation. The document should detail who is responsible for all debts, who will pay and when.
You also should close all joint credit cards to limit the potential liability. If you are an authorized user, it is fairly simple to get your name removed from that account. If you are a joint account holder, you have the right to close the account, or change the status of the account, so no future charges can be made to the account. If your account has a balance outstanding, make sure your separation agreement details who is responsible for this debt, who will pay and when. Once the account balance is zero, close the account completely.
You cannot disinherit your spouse–unless your spouse waives their marital estate inheritance rights. Another drawback to legal separation is that you cannot completely disinherit your spouse. In the eyes of the law, you are still married. That means that, depending on the laws of the state you reside in, your spouse has a right to inherit a part of your estate even if your will says otherwise. The legal separation is an order dictating the terms under which you would live separate and apart, not what would occur if either of you passed away. You can protect your assets by having a waiver of inheritance in your formal separation agreement.