Getting Divorced or Becoming Widowed

A few financial guides that require sober consideration if you’re getting divorced or have become widowed.

Financial Guides

What are the financial implications of marriage (and of divorce and re-marriage)? Those who have recently changed their marital status or who are planning such a change may have important financial and legal decisions to make. These decisions might deal with property ownership, providing for children’s welfare, post-mortem planning, and day-to-day finances.

This Financial Guide discusses financial considerations related to a change in marital status. And, because divorce is sometimes the flip side of a marriage–and often the bridge between marriage and remarriage–it is covered here as well.

Note: Under a joint IRS and U.S. Department of the Treasury ruling issued in 2013, same-sex couples, legally married in jurisdictions that recognize their marriages, are treated as married for federal tax purposes, including income and gift and estate taxes. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.

In addition, the ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit.

Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.

This guide will also briefly touch on legal issues involved; however, variations in state law make it nearly impossible to discuss in any detail the legal ramifications that a change in marital status presents.

How To Prepare Financially For A First Marriage

For the young, newly married couple, areas of financial concern primarily include: (1) life insurance, (2) form of property ownership, and (3) money management.

Life Insurance

When it comes to insurance needs, the basic rule is that you need enough coverage to sustain your family’s present income level should you die. If you are the only breadwinner, or if you plan on starting a family soon, then you should purchase life insurance.

Property Ownership

If you intend to buy a home or other property or if you and your spouse already own property together, then you need to consider the best way for you to hold that property. Will the property be held solely by one spouse? By both spouses jointly? Because of the complex legal implications of the various forms of property ownership, you should seek legal advice about this issue.

Money Management

It is important to carefully consider how the two of you will handle your day-to-day finances. New couples should be prepared to discuss financial goals, resolve differences (or at least agree to disagree) in spending habits, and establish a budget and/or saving and investment plan.

You’ll also need to think about whether you want a joint bank account, separate accounts, or both. How much do you want to spend on vacations? On monthly food bills? Entertainment? Gifts? Personal items? What are your long-term financial goals?

Do you have a financial plan? If you don’t, then now is the time to prepare one. Even if you do have a financial plan in place, since your marital status has changed it might be time to review and update it.

How To Prepare Financially For A Divorce

If you are considering divorce, it is vital to plan for the dissolution of the financial partnership in your marriage. Such dissolution involves dividing financial assets accumulated during the marriage. Further, if children are involved, future financial support for the custodial parent must be planned for.

While it may not be at the top of your to-do list, taking time to prepare financially during divorce pays off in the long run. Here are some steps you can take to get started.

Take Stock Of Your Situation

Assessing your financial situation helps you in two ways:

  • It will provide you with preliminary information for an eventual division of the property.
  • It will help you to plan how debts incurred during the marriage are to be paid off. Although the best way to deal with joint debt (such as credit card debt) is to pay it off before the divorce, this strategy is often impossible so compiling a list of your debts will help you to come to some agreement as to how they will be paid off.

To take stock of your situation start by preparing an inventory of your financial assets:

    • The current balance in all bank accounts;
    • The value of any brokerage accounts;
    • The value of investments, including any IRAs;
    • Your residence(s);
    • Your autos; and
    • Your valuable antiques, jewelry, luxury items, collections, and furnishings.
  1. Make sure you have copies of the past two or three years’ tax returns. These will come in handy later.
  2. Make sure you know the exact amounts of salary and other income earned by both yourself and your spouse.
  3. Find the papers relating to insurance-life, health, auto, and homeowner’s-and pension or other retirement benefits.
  4. List all debts you both owe, separately or jointly. Include auto loans, mortgage, credit card debt, and any other liabilities.

Tip: If you are a spouse who has not worked outside the home lately, be sure to open a separate bank account in your own name and apply for a credit card in your own name. These measures will help you to establish credit after the divorce.

Estimate Your Post-Divorce Living Expenses

Figure out how much it will cost you to live after the divorce. This is especially important for the spouse who is planning to remain in the family home with the children; it may be determined that the estimated living expenses are not manageable.

To estimate these expenses, add up all of your monthly debts and living expenses, including rent or mortgage. Then total your after-tax monthly income from all sources. The amount left over is your disposable income.

Cancel All Joint Accounts

It is important to cancel all joint accounts immediately once you know you are going to obtain a divorce because creditors have the right to seek payment from either party on a joint credit card or other credit account, no matter which party actually incurred the bill. If you allow your name to remain on joint accounts with your ex-spouse, you are also responsible for the bills.

Your divorce agreement may specify which one of you pays the bills. However, as far as the creditor is concerned both you and your spouse remain responsible if joint accounts remain open. The creditor will try to collect the bill from whoever it thinks may be able to pay while at the same time reporting the late payments to credit bureaus under both names. Your credit history could be damaged because of the co-signer’s irresponsibility.

Some credit contracts require that you immediately pay the outstanding balance in full if you close an account. If this is the case, then try to get the creditor to have the balance transferred to separate accounts.

If Your Spouse’s Poor Credit Affects You

If your spouse’s poor credit hurts your credit record, you may be able to separate yourself from the spouse’s information on your credit report. The Equal Credit Opportunity Act requires a creditor to take into account any information showing that the credit history being considered does not reflect your own. If for instance, you can show that accounts you shared with your spouse were opened by him or her before your marriage, and that he or she paid the bills, you may be able to convince the creditor that the harmful information relates to your spouse’s credit record, not yours.

In practice, it is difficult to prove that the credit history under consideration does not reflect your own, and you may have to be persistent.

For Women: Maintain Your Own Credit Before You Need It

If a woman divorces, and changes her name on an account, lenders may review her application or credit file to see whether her qualifications alone meet their credit standards. They may ask her to reapply even though the account remains open.

Maintaining credit in your own name is the best way to avoid this inconvenience. It also makes it easier to preserve your own, separate, credit history. Further, should you need credit in an emergency it will be available when you need it.

Do not use only your husband’s name (for example, Mrs. John Wilson) for credit purposes.

Tip: Check your credit report if you have not done so recently. Make sure the accounts you share are reported in your name as well as your spouse’s name. If not, and you want to use your spouse’s credit history to build your own credit, write to the creditor and request that the account be reported in both names.

Also, carefully review your credit report to determine whether there is any inaccurate or incomplete information. If there is, write to the credit bureau and ask them to correct it. The credit bureau must confirm the data within a reasonable time period, and let you know when they have corrected the mistake.

If you have been sharing your husband’s accounts, building a credit history in your name should be fairly easy. Call a major credit bureau and request a copy of your report. Contact the issuers of the cards you share with your husband and ask them to report the accounts in your name as well.

If you used the accounts, but never co-signed for them, ask to be added on as jointly liable for some of the major credit cards. Once you have several accounts listed as references on your credit record, apply for a department store card, or even a Visa or MasterCard, in your own name.

If you held accounts jointly and they were opened before 1977 (in which case they may have been reported only in your husband’s name), point them out and tell the creditor to consider them as your credit history also. The creditor cannot require your spouse’s or former spouse’s signature to access his credit file if you are using his information to qualify for credit.

Tip: If you do not have a credit history, a secured credit card is a fairly quick and easy way to get a major credit card. Secured credit cards look and are used like regular Visa or MasterCard’s, but they require a savings or money market deposit of several hundred dollars that the lender holds in case you default. In most cases, the creditor will report your payment record on these accounts just like a regular bankcard, allowing you to build a good credit record if you pay your bills promptly.

Consider the Legal Issues

The best way to plan for the legal issues involved in a divorce including child custody, division of property, and alimony or support payments is to come to an agreement with your spouse. If you can reach an agreement, the time and money you will have to expend in coming up with a legal solution–either one worked out between the two attorneys or one worked out by a court–will be drastically reduced.

Here are some general tips for handling the legal aspects of a divorce:

  • Get your own attorney if there are significant issues to deal with such as child custody, alimony, or significant assets.
  • The best way to find a good matrimonial attorney is to ask for referrals or contact the American Academy of Matrimonial Lawyers (see the last section of this guide for contact information).
  • Make sure the divorce decree or agreement covers all types of insurance coverage including life, health, and auto.
  • Be sure to change the beneficiaries on life insurance policies, IRA accounts, 401(k) plans, other retirement accounts, and pension plans.
  • Don’t forget to update your will.

Tip: Those who have trouble arriving at an equitable agreement–and who do not require the services of an attorney–might consider the use of a divorce mediator. Ask friends, relatives, and other professionals for recommendations or contact the Association for Conflict Resolution (see the last section of this guide for contact information). You can also look in the phone book or classifieds under “Divorce Assistance” or “Lawyer Alternatives.”

Division of Property

The laws governing division of property between ex-spouses vary from state to state. Further, matrimonial judges have a great deal of latitude in applying those laws.

Here is a list of items you should be sure to take care of, regardless of whether you are represented by an attorney.

  1. Understand how your state’s laws on property division work.
  2. If you owned property separately during the marriage, be sure you have the papers to prove that it has been kept separate.
  3. Be ready to document any non-financial contributions to the marriage such as support of a spouse while he or she attended school or non-financial contributions to his or her financial success.
  4. If you need alimony or child support, be ready to document your need for it.
  5. If you have not worked outside the home during the marriage, consider having the divorce decree provide for money for you to be trained or educated.

How To Prepare Financially For Re-Marriage

When considering remarriage, it is important to plan for the following:

  • Whether property acquired before the marriage will be held jointly
  • How to provide for children from a previous marriage
  • Whether a prenuptial agreement is necessary to accomplish goals related to either of these issues

If either spouse has significant assets, it will be necessary to consult an attorney.

As for the estate planning aspects of providing for children from a previous marriage, trusts and/or life insurance are the vehicles most often used to do this.

Tip: Be sure to update your will before you remarry to ensure that your assets will be divided among your heirs after your death in the manner and proportions you desire.

Government and Non-Profit Agencies

    • American Academy of Matrimonial Lawyers (AAML)
      150 North Michigan Ave., Suite 1420
      Chicago, IL 60601
      Tel. 312-263-6477
      www.aaml.org

    • Association for Conflict Resolution (ACR)
      12100 Sunset Hills Rd., Suite #130
      Reston, VA 20190
      Tel. 703.234.4141
      www.acrnet.org
    • National Foundation for Credit Counseling (NFCC)
      Tel. 800-388-CCCS (2227)
      www.nfcc.org
  • Ex-Partners of Servicemen/women for Equality (EX-POSE)
    P.O. Box 11191
    Alexandria, VA 22312
    Tel. 703-255-2917
    www.ex-pose.org
    This non-profit organization provides information to divorcing or separating spouses of military service people.
How much life insurance do you need? What type is appropriate? You should review your life insurance needs each time you have a major life event. Here is what you need to know to properly plan for your life insurance needs to buy enough and to get the most for your money.

Life Insurance Frequently Asked Questions

Frequently Asked Questions

Legal Rights: What are the major differences between married and unmarried couples?

When it comes to legal rights and being married vs. unmarried, there are several major issues to consider. Specifically, unmarried couples do not:

  • Automatically inherit each others’ property. Married couples who do not have a will have their state intestacy laws to back them up; the surviving spouse will inherit at least a fraction of the deceased spouse’s property under the law.
  • Have the right to speak for each other in a medical crisis. If your life partner loses consciousness or capacity, someone will have to make the decision whether to go ahead with a medical procedure. That person should be you. But unless you have taken care of some legal paperwork, you may not have the right to do so.
  • Have the right to manage each others’ finances in a crisis. A husband and wife who have jointly owned assets will generally be affected less by this problem than an unmarried couple.

What estate and financial planning steps are particularly important for unmarried couples?

The following steps are particularly important for couples who are not married:

  • Prepare a will. If both partners make out wills, the chances are that the intentions expressed in the wills will be followed after one partner dies. If there are no wills, the unmarried surviving partner will probably be left high and dry.
  • Consider owning property jointly. Joint ownership of property with right of survivorship is a way of ensuring that property will pass to the other joint owner on one joint owner’s death. Real property and personal property can be put into this form of ownership.
  • Prepare a durable power of attorney. Should you become incapacitated, the durable power of attorney will allow your partner to sign papers and checks for you and take care of other financial matters on his or her behalf.
  • Prepare a health care proxy. The health care proxy (sometimes called a “medical power of attorney”) allows your partner to speak on your behalf when it comes to making decisions about medical care, should you become incapacitated.
  • Prepare a living will. A living will is the best way to let the medical community know what your wishes are regarding artificial feeding and other life-prolonging measures.

Do married couples need life insurance?

The purpose of life insurance is to provide a source of income for your children, dependents, or whoever you choose as a beneficiary, in case of your death. Therefore, married couples typically need more life insurance than their single counterparts. If you have a spouse, child, parent, or some other individual who depends on your income, then you probably need life insurance. Here are some typical families that need life insurance:

  • Families or single parents with young children or other dependents. The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts. If the family cannot afford to insure both wage earners, the primary wage earner should be insured first, and the secondary wage earner should be insured later on. A less expensive term policy might be used to fill an insurance gap. If one spouse does not work outside the home, insurance should be purchased to cover the absence of the services being provided by that spouse (child care, housekeeping, and bookkeeping). However, if funds are limited, insurance on the non-wage earner should be secondary to insurance on the life of the wage earner.
  • Adults with no children or other dependents. If your spouse could live comfortably without your income, then you will need less insurance than the people in situation (1). However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse. If your spouse would undergo financial hardship without your income, or if you do not have adequate savings, you may need to purchase more insurance. The amount will depend on your salary level and that of your spouse, on the amount of savings you have, and on the amount of debt you both have.
  • Single adults with no dependents. You will need only enough insurance to cover burial expenses and debts, unless you want to use insurance for estate planning purposes.
  • Children. Children generally need only enough life insurance to pay burial expenses and medical debts. In some cases, a life insurance policy might be used as a long-term savings vehicle.

If one spouse changes their name after marriage, who should be notified?

You should notify all organizations with which you previously corresponded with your maiden name. The following is good list to start with:

  • The Social Security Administration
  • Driver’s license bureau
  • Auto license bureau
  • Passport office
  • Employer
  • Voter’s registration office
  • School alumni offices
  • Investment and bank accounts
  • Insurance agents
  • Retirement accounts
  • Credit cards and loans
  • Subscriptions
  • Club memberships
  • Post Office

Do I need to update my will when I get married?

Absolutely. Your will should be updated often, especially when such a significant life event occurs. Otherwise you spouse and other intended beneficiaries may not get what you intended upon your death.

What are the tax implications of marriage?

Once you are married you are entitled to file a joint income tax return. While this simplifies the filing process, you may find your tax bill either higher or lower than if each of you had remained single. Where it’s higher it’s because when you file jointly more of your income is taxed in the higher tax brackets. This is frequently referred to as the “marriage tax penalty.” Tax law changes in the form of marriage penalty relief were made permanent by the American Taxpayer Relief Act of 2012, but don’t eliminate the penalty for taxpayers in the higher brackets.

You cannot avoid the marriage penalty by filing separate returns after you’re married. In fact filing as “married filing separately” can actually increase your taxes. Consult your tax advisor if you have questions about the best filing status for your situation.

Note: Under a joint IRS and U.S. Department of the Treasury ruling issued in 2013, same-sex couples, legally married in jurisdictions that recognize their marriages, are treated as married for federal tax purposes, including income and gift and estate taxes. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.

In addition, the ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit.

Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.

How can married couples hold property?

There are several ways of owning property after marriage, but keep in mind that they may vary from state to state. Here are the most common:

  • Sole Tenancy. Ownership by one individual. At death the property passes according to your will.
  • Joint Tenancy, with right of survivorship. Equal ownership by two or more people. At death property passes to the joint owner’s. This is an effective way of avoiding probate.
  • Tenancy in Common. Joint ownership of property without the right of survivorship. At death your share of the property passes according to your will.
  • Tenancy by the Entirety. Similar to Joint Tenancy, with right of survivorship. This is only available for spouses and prevents one spouse from disposing of the property without the others permission.
  • Community Property. In some states, referred to as community property states, married people own property, assets, and income jointly; that is, there is equal ownership of property acquired during a marriage. Community property states are AZ, CA, ID, LA, NV, NM, TX, WA, and WI.

How do I prepare financially for divorce?

If you are considering divorce, it’s vital to plan for the dissolution of the financial partnership in your marriage. This means dividing the financial assets and liabilities you have accumulated during the years of marriage. Further, if children are involved, the future support given to the custodial parent must be planned for.

The time you take to prepare and plan for eventualities will pay off later on. Here is what you can do:

Making an inventory of your financial situation will help you to prepare in two ways:

  1. It will provide you with preliminary information for an eventual division of the property.
  2. It will help you to plan how the debts incurred in the marriage are to be paid off. Although the best way of dealing with joint debt, such as credit card debt, is to get it all paid off before the divorce, often this is not possible. Having a list of your debts will help you to come to some agreement as to how they will be paid off.

First, make a list of all of your assets, joint or separate, including:

  • The current balance in all bank accounts
  • The value of any brokerage accounts
  • The value of investments, including any IRAs
  • Your residence(s)
  • Your autos
  • Your valuable antiques, jewelry, luxury items, collections, and furnishings

Next, make sure you have copies of the past two or three years’ tax returns. These will come in handy later.

Make sure you know the exact amounts of salary and other income earned by both yourself and your spouse.

Find any papers relating to insurance-life, health, auto, and homeowner’s, as well as pension and other retirement benefits.

Next, list all debts you both owe, separately or jointly. Include auto loans, mortgage, credit card debt, and any other liabilities.

Tip: If you are a spouse who has not worked outside the home lately, be sure to open a separate bank account in your own name and apply for a credit card in your own name. This will help you to establish credit after the divorce.

How should we handle credit card accounts during a divorce?

First, it is important to cancel all joint accounts immediately once you know you are going to obtain a divorce.

Creditors have the right to seek payment from either party on a joint credit card or other credit account, no matter which party actually incurred the bill. If you allow your name to remain on joint accounts with your ex-spouse, you are also responsible for the bills.

Your divorce agreement may specify which one of you pays the bills. As far as the creditor is concerned, however, both you and your spouse remain responsible if the joint accounts remain open. The creditor will try to collect the bill from whoever it thinks may be able to pay, and at the same time report the late payments to the credit bureaus under both names. Your credit history could be damaged because of the cosigner’s irresponsibility.

Some credit contracts require that you immediately pay the outstanding balance in full if you close an account. If so, try to get the creditor to have the balance transferred to separate accounts.

What do I do if my current or former spouse’s poor credit affects me?

If your spouse’s poor credit hurts your credit record, you may be able to separate yourself from your spouse’s information on your credit report. The Equal Credit Opportunity Act requires a creditor to take into account any information showing that the credit history being considered does not reflect your own. If for instance, you can show that accounts you shared with your spouse were opened by him or her before your marriage and that he or she paid the bills, you may be able to convince the creditor that the harmful information relates to your spouse’s credit record, not yours.

In practice, it is difficult to prove that the credit history under consideration doesn’t reflect your own, and you may have to be persistent.

What happens to my credit history after a divorce?

If a woman divorces, and changes her name on an account, lenders may review her application or credit file to see whether her qualifications alone meet their credit standards. They may ask her to reapply. (The account remains open.)

Maintaining credit in your own name avoids this inconvenience. It can also make it easier to preserve your own, separate, credit history. Further, should you need credit in an emergency, it will be available.

Do not use only your husband’s name, for example, Mrs. John Wilson for credit purposes.

Tip: Check your credit report if you haven’t done so recently. Make sure the accounts you share are being reported in your name as well as your spouse’s. If not, and you want to use your spouse’s credit history to build your own, write to the creditor and request the account be reported in both names.

Also, determine if there is any inaccurate or incomplete information in your file. If so, write to the credit bureau and ask them to correct it. The credit bureau must confirm the data within a reasonable time period, and let you know when they have corrected the mistake.

If you have been sharing your husband’s accounts, building your own credit history in your name should be fairly easy. Call a major credit bureau and request a copy of your file. Contact the issuers of the cards you share with your husband and ask them to report the accounts in your name as well.

What are the legal issues that must be faced in most divorces?

The best way to plan for the legal issues that must be faced in a divorce such as child custody, division of property, and alimony or support payments, is to come to an agreement with your spouse. If you can do this, the time and money you will have to expend in coming up with a legal solution–either one worked out between the two attorneys or one worked out by a court–will be drastically reduced.

Here are some general tips for handling the legal aspects of a divorce:

  • Get your own attorney if there are significant issues dealing with assets, child custody, or alimony.
  • There are several ways to find a good matrimonial attorney including referrals from other professionals, referrals from trusted friends, or lists obtained from the American Academy of Matrimonial Lawyers.
  • Make sure the divorce decree or agreement covers all types of insurance coverage-life, health, and auto.
  • Be sure to change the beneficiaries on life insurance policies, IRA accounts, 401(k) plans, other retirement accounts, and pension plans.
  • Don’t forget to update your will.

Tip: Those who have trouble arriving at an equitable agreement, but do not require the services of an attorney, might consider the use of a divorce mediator. This type of professional advertises in the section of the classifieds titled “Divorce Assistance”, or “Lawyer Alternatives.”

How does property get divided in a divorce?

The laws governing division of property between ex-spouses vary from state to state. Further, matrimonial judges have a great deal of latitude in applying those laws.

Here is a list of items you should be sure to take care of, regardless of whether you are represented by an attorney.

  1. Gain an understanding of how your state’s laws on property division work.
  2. If you owned property separately during the marriage, be sure you have the papers to prove that it’s been kept separate.
  3. Be ready to document any non-financial contributions to the marriage, e.g., your support of a spouse while he or she attended school or your non-financial contributions to his or her financial success.
  4. If you need alimony or child support, be ready to document your need for it.

If you have not worked outside the home during the marriage, consider having the divorce decree provide for money for you to be trained or educated.

What are the tax implications of divorce?

After divorce each individual will file their own tax return. However, there are several areas where transactions between former spouses can result in tax consequences. The most common areas are:

Child Support

Child support is not deductible by the payer and is not taxable to the recipient. A payment is considered to be child support if it is specifically designated as such in a divorce or separation agreement or if it is reduced by the occurrence of a contingency related to the child (such as attaining a certain age).

Alimony

Alimony is deductible by the payer and is taxable to the recipient. Alimony is a payment made pursuant to a divorce decree other than child support or designated as something in the instrument as other than alimony. Similar treated is accorded separate maintenance payments made pursuant to a separation agreement. In order to qualify, payments must also cease upon the death of the recipient and must not be front-loaded.

Property Settlements

Property settlements are not taxable events when pursuant to divorce or separation. Transfers of assets between spouses in this event do not result in taxable income, deductions, gains or losses. The cost basis of the property carries over to the recipient spouse. Be careful in a divorce, your spouse may give you an equal share of property based upon fair market value, but with the lower basis. This can result in a higher taxable gain upon a sale of the asset.

What happens when retirement plans or IRAs are divided up in a divorce?

Generally, when these plans are split up there is no taxable event if pursuant to a qualified domestic relations order or other court order in the case of an IRA. This is true, however, only if the assets remain in a retirement account or IRA. Once funds are distributed they will be taxed to the recipient. At the time of division, the payer does not receive a deduction and the recipient does not have taxable income.

Can I deduct the cost of getting a divorce?

Generally, no; however, fees paid specifically for income or estate tax advice pursuant to a divorce may be deductible. Also, fees made to determine the amount of alimony or to collect alimony can be deducted. These deductions would be miscellaneous itemized deductions subject to the 2% limitation.

Who is entitled to deduct the dependency exemption of a child after divorce?

Generally, the custodial parent is entitled to the deduction. However, this is often negotiated in the divorce settlement. If the parents agree in writing, the non-custodial parent can take the deduction.

When should I start saving for my child’s education?

This depends on how much you think your children’s education will cost. The best way is to start saving before they are born. The sooner you begin the less money you will have to put away each year.

Example: Suppose you have one child, age six months, and you estimate that you’ll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you’ll need to save $3,500 per year for 18 years (assuming an after-tax return of 7 percent). On the other hand, if you put off saving until the child is six years old, you’ll have to save almost double that amount every year for twelve years.

Another advantage of starting early is that you’ll have more flexibility when it comes to the type of investment you’ll use. You’ll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments in the long-run.

How much will my child’s college education cost?

It depends on whether your child attends a private or state school. According to the College Board, average published tuition and fees for full-time in-state students at public four-year colleges and universities increased 2.9% before adjusting for inflation, rising from $9,145 in 2014-15 to $9,410 in 2015-16. Average published tuition and fees at private nonprofit four-year institutions increased 3.6% before adjusting for inflation, rising from $31,283 in 2014-15 to $32,405 in 2015-16. Undergraduates received an average of $14,210 in financial aid in 2014-15, including $8,170 in grants from all sources, $4,800 in federal loans, $1,170 in education tax credits and deductions, and $70 in Federal Work-Study.

How should I invest my child’s college fund?

As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different, from those used if you start when your child is age 12.

The following are often recommended as investments for education funds:

    • Series EE bonds: These are extremely safe investments. They should be held in the parents’ names. If the adjusted gross income of you and your spouse at the time of redemption is at or under the amount set by the tax law, the interest on bonds bought after January 1, 1990, is tax-free as long as it is used for tuition or other qualified education costs. If your adjusted gross income is above the threshold amount, the tax break is phased out. In 2016, the exclusion ($76,000 indexed for inflation) begins phasing out at $77,200 modified adjusted gross income and is eliminated for adjusted gross incomes of more than $92,200. For married taxpayers filing jointly, the tax exclusion begins to be reduced with a $115,750 modified adjusted gross income and is eliminated for adjusted gross incomes of more than $145,750. The exclusion is unavailable to married filing separately.
    • U.S. Government bonds: These are also investments that offer a relatively higher return than CDs or Series EE bonds. If you use zero-coupon bonds, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don’t receive it until maturity.
    • Certificates of deposit: These are safe, but usually provide a lower return than the rate of inflation. The interest is taxable. These should generally only be used by the most risk averse investors and for relatively short investment horizons.
    • Municipal bonds: Assuming the bonds are highly rated, the tax-free interest on them can provide an acceptable return if you’re in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child’s life.

Tip: Be sure to convert the tax-free return quoted by sellers of such bonds into an equivalent taxable return. Otherwise, the quoted return may be misleading. The formula for converting tax-free returns into taxable returns is as follows:

Divide the tax-free return by 1.00 minus your top tax rate to determine the taxable return equivalent. For example, if the return on municipal bonds is 5 percent and you are in the 30 percent tax bracket, the equivalent taxable return is 7.1 percent (5 percent divided by 70 percent).

  • Stocks: An appropriate mutual fund or portfolio containing stocks can provide you with a higher yield than bonds at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.

What is the American Opportunity Tax Credit?

The American Opportunity Tax Credit (AOC) was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH). The maximum credit, available only for the first four years of post-secondary education, is $2,500. You can claim the credit for each eligible student you have for which the credit requirements are met.

Income limits. To claim the American Opportunity Credit, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $60,000 ($120,000 for joint filers). “Modified AGI” generally means your adjusted gross income. The “modifications” only come into play if you have income earned abroad.

Amount of credit. For most taxpayers, 40 percent of the AOC is a refundable credit, which means that you can receive up to $1,000 even if you owe no taxes.

Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.

“Related” expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.

Tip: The tax law says that you can’t claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.

What is the “kiddie tax?”

In the past, parents would invest in the child’s name in order to shift income to the lower-bracket child. However, the addition of the “kiddie tax” mostly put an end to that strategy.

For taxable years beginning in 2016, the amount that can be used to reduce the net unearned income reported on the child’s return that is subject to the “kiddie tax” is $1,050 (same as 2015). The same $1,050 amount is used to determine whether a parent may elect to include a child’s gross income in the parent’s gross income and to calculate the “kiddie tax.” For example, one of the requirements for the parental election is that a child’s gross income for 2016 must be more than $1,050 but less than $10,500.

For 2016, the net unearned income for a child under the age of 19 (or a full-time student under the age of 24) that is not subject to “kiddie tax” is $2,100 (same as 2015).

Note: These rules apply to unearned income. If a child has earned income, this amount is always taxed at the child’s rate.

What is a Coverdell Education Savings Account – Section 530 Program (formerly Education IRA) and who is eligible for one?

In 2016, you can contribute up to $2,000 each year to a Coverdell education savings account (Section 530 program) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year (say 2016) can be made through the (unextended) due date for the return for that year (April 18, 2017).

Note: For the $2,000 contribution limit, there is no adjustment for inflation and therefore, the limit is expected to remain at $2,000 for 2013 and beyond.

Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.

Anyone can establish and contribute to a Section 530 account, including the child, and you may establish 530s for as many children as you wish. The child need not be a dependent. In fact, he or she need not be related to you, but the amount contributed during the year to each account cannot exceed $2,000. In 2016, the maximum contribution amount for each child is phased out for modified AGI between $190,000 and $220,000 (joint filers) and $95,000 and $110,000 (single filers).

If you have insufficient savings for your child’s education when he is close to entering college, what should you do?

Many families find themselves in the same boat. Fortunately, there are ways to generate additional funds both now and when your child is about to enter school:

  • You can start saving as much as possible during the remaining years. However, unless your income level is high enough to support an extremely stringent savings plan, you will probably fall short of the amount you need.
  • You can take on a part-time job. However, this will raise your income for purposes of determining whether you are eligible for certain types of student aid. In addition, your child may be able to take on part-time or summer jobs.
  • You can tap your assets by taking out a home equity loan or a personal loan, selling assets or borrowing from a 401(k) plan.
  • You (or your child) can apply for various types of student aid and education loans.

What types of grants are available for college?

Grants-the best type of financial aid because they do not have to be paid back — are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.

    • The Federal Pell Grant Program offers federal aid based on need.

Tip: Don’t assume that middle class families are ineligible for needs-based aid or loans. The assessment of whether a family qualifies as “in need” depends on the cost of the college and the size of the family.

  • State education departments may make grants available. Inquiries should be made of the state agency.
  • Employers may provide subsidies.
  • Private organizations may provide scholarships. Inquiries should be made at schools.
  • Most schools provide aid and scholarships, both needs-based and non-needs-based.
  • Military scholarships are available to those who enlist in the Reserves, National Guard, or Reserve Officers Training Corps. Inquiries should be made at the branch of service.

Tip: Try negotiating with your preferred college for additional financial aid, especially if it offers less than a comparable college.

What types of grants are available for college?

There are various student loan programs available. Some are need-based, and others are not. Here is a summary of loans:

  • Stafford loans (formerly guaranteed student loans) are federally guaranteed and subsidized low-interest loans made by local lenders and the federal government. They are needs-based for subsidized loans; however an unsubsidized version is also available.
  • Perkins loans are provided by the federal government and administered by schools. They are needs-based. Inquiries should be made at school aid offices.
  • Parent loans for undergraduate students (PLUS) and supplemental loans for students are federally guaranteed loans by local lenders to parents, not students. Inquiries should be made at college aid offices.
  • Schools themselves may provide student loans. Inquiries should be made at the school.

How can I increase the amount of financial aid my child is entitled to?

Here are some strategies that may increase the amount of aid for which your family is eligible:

    • Try to avoid putting assets in your child’s name. As a general rule, education funds should be kept in the parents’ names, since investments in a child’s name can impact negatively on aid eligibility. For example, the rules for determining financial aid decrease the amount of aid for which a child is eligible by 35 percent of assets the child owns and by 50 percent of the child’s income.

Example: If your child owns $1,000 worth of stock, the amount of aid for which he or she is eligible for is reduced by $350. On the other hand, the amount of aid is reduced by (effectively) only 5.6 percent of your assets and from 22 to 47 percent of your income.

  • Reduce your income. Income for financial aid purposes is generally determined based upon your previous year’s income tax situation. Therefore, in the years immediately prior to and during college, try to reduce your taxable income. Some ways to do this include:
    1. Defer capital gains.
    2. Sell losing investments.
    3. Reduce the income from your business. If you are the owner of your own business, you may be able to reduce your taxable income by taking a lower salary, deferring bonuses, etc.
    4. Avoid distributions from retirement plans or IRAs in these years.
    5. Pay your federal and state taxes during the year in the form of estimated payments rather than waiting until April 15 of the following year.
    6. Since a portion of discretionary assets is included in the family’s expected contribution from income, reduce discretionary assets by paying off credit cards and other consumer loans.
    7. Take advantage of vehicles which defer income, such as 401(k) plans, other retirement plans or annuities.
  • Detail any financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are if they are not clear from the application. The financial aid officer may be able to assist you in explaining hardships.
  • Have your child become independent. In this case, your income is not considered in determining how much aid your child will be eligible for. Students are considered independent if they:
    1. Are at least 24 years old by the end of the year for which they are applying for aid
    2. Are veterans
    3. Have dependents other than their spouse
    4. Are wards of the court or both parents are deceased
    5. Are graduate or professional students
    6. Are married and are not claimed as dependents on their parents’ returns

How can I save taxes on college savings?

If you decide to invest in your child’s name, here are some tax strategies to consider:

  • You can shift just enough assets to create $2,100 in 2016 (same as 2015) taxable income to an under-19 child.
  • You can buy U.S. Savings Bonds (in the child’s name) scheduled to mature after your child reaches age 18.
  • You can invest in equities that pay small dividends but have a lot of potential for appreciation. The dividend income earned when your child is under the age of 19 will be minimal with tax relief, and the growth in the stocks will occur over the long term.
  • If you own a family business, you can employ your child in the business. Earned income is not subject to the “kiddie tax,” and is deductible by the business if the child is performing a legitimate function. Additionally, if your business is a sole proprietorship and your child is younger than 19 years old, then he or she will not pay social security taxes on the income.
See our Frequently Asked Questions about Life Insurance:

Life Insurance Frequently Asked Questions

Financial Calculators