Frank and Kathy Explore Divorce

A Couple Explore a Divorce Settlement

The Facts

Married Couple: Frank’s age: 52, Kathy’s age: 45
Franks's earnings: $750,000
Kathy's earnings: $0

Frank’s 401(k) savings: $1.5 million
Kathy’s retirement accounts: $0
Joint savings: $500K

The Base Plan

Kathy, age 45, and Frank, age 52, are going through a rough patch and are thinking about getting divorced. The couple lives in Kentucky with their 10 year-old daughter, Samantha, and their 15 year-old son, Victor. Frank is a well-paid cardiologist who earns $750,000 per year. He has a $1.5 million 401(k). The couple has a $500,000 joint savings account and owns a $2 million home with a $1 million mortgage.

Kathy worked in the past to put Frank through medical school. But once Victor arrived, she became a full-time mom. Consequently, she has no retirement account assets. Kathy has found a part-time job paying $25,000 per year and expects to work full time (doubling her salary) when Samantha heads to college. Going forward, both Frank and Kathy’s employers will contribute 3 percent to their 401(k)s – matching Frank and Kathy’s own 3 percent contributions. The couple plans to spend $75,000 in today’s dollars on each child for their four years of college.

They’ve used MaxiFi to calculate their future living standard if they stay together. The answer is $82,228 per person – this is discretionary spending per household member adjusted for economies in shared living and the relative cost of children.

The What If Plan

Frank and Kathy’s Living Standard If They Divorce

To understand their living standard if they divorce, Frank and Kathy use Analyze My Divorce Settlement (AMDS) is a sister program to MaxiFi. It compares the sustainable living standard of each spouse under any specified divorce settlement.

In running AMDS, Frank and Kathy specify a 50-50 split of their assets, a 50-50 split of the proceeds of the sale of their house when it’s sold, child support from Frank to Kathy based on Kentucky State’s guideline. They also assume that Kathy will live in their home with the children for 9 years, which is when Samantha will head to college. Apart from their mortgage, their current home costs, on an annual basis, $20,000 in property taxes, $4,000 in insurance, and $3,000 in maintenance. Before they sell their home, Frank will cover all housing expenses. He'll also handle all college expenses for each child. Once they sell, Kathy will purchase the same $500,000 condo, which Frank will purchase immediately. The condo costs, per year, $5,000 in property taxes, $1,000 in insurance, and $3,600 in condo fees.

Kentucky's child support guideline calls for a $1,849 monthly payment when both children are at home, falling to $1,199 after Victor goes to college. Finally, they set Frank’s annual alimony through retirement at 65 at $77,000 (in today's dollars) - the amount needed to equalize (within a few dollars) both of their living standards going forward. Living standard only references welfare arising from discretionary spending. For the next 9 years, Kathy will enjoy living in a home that's 4 times more valuable than the condo into which Frank will immediately move.

Both Frank and Kathy are surprised that the alimony is only $77,000. After all, Frank earns 30 times more than Kathy. True. But Frank has to pay dramatically higher taxes than Kathy. He also has to carry all expenses on two houses for the next 9 years, his own plus the couple's current home. Finally, he has to pay 4 years times 2 children times $75,000, i.e. $600,000 in total college expenses.

To their dismay, AMDS produces an annual discretionary spending level (living standard) of only $64,055 per person. That’s a 28.4 percent reduction compared to staying married!

The living standard drop reflects three factors, one of which goes in the opposite direction from the other two. First, if they divorce, they lose economies of shared living; i..e, the fact that two can live more cheaply than one. MaxiFi assumes that 2 can live as cheaply 1.6. This means that two people living together and spending $160,000 can each achieve the same living standard as they would on their own, but spending $100,000 each. Second, if they divorce, they will downside their collective housing, going, eventually from $2 million to $1 million in total house value. This saving on housing costs permits a higher living standard. Third, when they divorce they need two homes, which means two property tax bills, two mortgages, two insurance policies, and two sets of maintenance bills. This, too, makes divorce costly.

What To Do?

Frank and Kathy are mulling things over. Suffering a 28.4 percent living standard decline for the rest of their lives is no minor manner. Last we heard, they were checking out marriage counselors.