Luke and Liz, age 40, are getting divorced after 20 years of marriage.
Married couple: Luke’s age: 40, Liz’s age: 40
Combined 401(k): $600K
Combined earnings: $200K
Regular Assets: $500K
The Base Plan
Luke and Liz, age 40, are getting divorced after 20 years of marriage. The couple lives with their 5-year old twins, Nick and Noah, in New Hampshire. Liz and Luke earn $100,000 each per year. They each have $300,000 in a 401(k) to which they and their employer contribute 3 percent of their pay. The couple also have $500,000 in joint savings (regular assets). Luke and Liz both intend to retire when they turn 65 and take Social Security benefits at age 66. Liz will have full custody of Nick and Noah. Luke and Liz will share the twins’ college expenses to the tune of $30,000 (in today’s dollars) per year for four years. Jeff proposes splitting their regular assets and his 401(k) 50-50. He feels his proposal is fair and that there is no reason to pay child support.
Liz runs Analyze My Divorce Settlement (AMDS) to see how Luke’s discretionary spending will compare with hers under his proposal. The tool calculates these amounts through each spouse’s maximum age of life, which are, in this example, set at 100. Discretionary spending references all outlays apart from fixed expenses, which in this case encompasses federal and state taxes, retirement account contributions, and Medicare Part B premiums.
Based on Luke’s proposed settlement, Luke can spend $58,590 on a discretionary basis through age 100. Liz, however, can only spend $51,889 per year through her age 100. Hence, Luke is proposing that he enjoy, on an ongoing basis, a 13 percent higher living standard than Liz. What explains the difference? It’s not the division of assets since that’s 50-50. It’s not differences in labor earnings since Luke and Liz now earn and will earn the same. Instead, it’s Jinny’s need to provide sole support for Nick and Noah. Analyze My Divorce Settlement assumes that children will have the same living standard as the parent when they are living with the parent. Thus, if custody is 70-30 between Liz and Luke, the program calculates outlays on children for each parent that a) ensure the children have the same living standard as the parent when they reside with the parent and b) take into account the shares of time they will live with each parent.
Creating What-If Scenarios
Luke Pays Child Support to Liz
The State of New Hampshire’s policy on child support is that “Parents must also share child care and medical expenses and may also have to cover other costs, like those for education.” The state’s child support guidelines reference its child support calculator, which takes into account each parent’s gross income, state income taxes, children’s medical expenses and the child custody arrangement. According to the calculator, the monthly amount of child support that Luke owes Liz is $1595 or $19,140 annually. In running the program, Liz assumes that this amount of child support will continue until the twins turn 18. The result? Luke’s and Liz’s discretionary spending levels are now $55,810 and $57,333, respectively. Liz is better-off by 10.5 percent compared to the base case.
What Child Support Will Equalize Their Living Standards?
Luke feels that he and Liz should enjoy the same living standard once they are divorced. He runs AMDS repeatedly with different levels of child support until he finds the level that produces equal spending going forward. Yearly child support of $15,170 (on an inflation-adjusted basis) does the trick, permitting them both to spend $54,951, apart from their fixed costs (e.g., taxes), on an ongoing bias. Hence, the state of New Hampshire’s child support guideline is overly generous. It is too high by 26.2 percent. Based on his calculations, Luke and Liz agree to reduce child support to $15,170 per year. (The couple can achieve the same outcome by setting child support based on the state guideline, but have Liz pay Luke alimony of $3750 per year until the children reach 19.)
What-If Liz and Luck Hit the Jackpot?
Now suppose that Liz and Luke win the lottery, skyrocketing their regular assets to $4 million. Luke’s and Liz’s discretionary spending are now $84,018 and $81,347, respectively. To equalize their living standards, Luke would have to pay $25,900, not $19,140 in annual child support. This will equalize their sustainable discretionary spending at $82,571. Hence, the state child support guideline, in this case, is too low by 35.3 percent.
What If Liz and Luke Earn Half as Much and Have No Regular Assets?
In this case, the NH child support guideline is $914 per month or $10,968 annually. Running the program with this level of child support, Luke’s and Liz’s discretionary spending are $33,975 and $37,464, respectively. Again, the child-support guideline is too high, in this case miles too high. The correct guideline – the guideline that equalizes each spouse’s discretionary spending at, in this case, $36,232, is $1250. Hence, the state guideline is too high by 777.4 percent.
In the three cases considered, New Hampshire’s child support was too high by 26.2 percent, too low by 35.3 percent and too high by 777.4 percent, respectively. We could easily produce many more examples of problems with New Hampshire’s child-support guideline formula. But the point is clear. The state’s formula is simply a rule of thumb, which is guaranteed to produce the wrong level of child support with the size of the mistake depending on the couple’s situation and child custody arrangement. Rather than guess at the proper guideline, the State of New Hampshire should instruct judges to use Analyze My Divorce Settlement to set child support and, for that matter, alimony on a case by case basis.
Although we’ve focused here on New Hampshire, child-support guidelines will be off target for all states that specifies guideline formulas. Moreover, the fact that the formulas differ by state is itself evidence that there is a major problem in this method of determining child support. Children are surely not more or less deserving of support simply because they live in one state rather than another.