The Ins and Outs of Spousal Support Buyouts

A spousal support buyout is a transfer of assets (cash, retirement, home equity, etc.) instead of paying monthly spousal support payments.  A “spousal support buyout” usually refers to a complete buyout of support.  A “partial” support buyout usually refers to a transfer in addition to monthly support payments, but which reduces either the amount or duration of spousal support.

Why do people do support buyouts?

Spousal support buyouts are not real common, but they do occur and can be a good option in certain situations.  There are several reasons that people will do buyouts instead of pay monthly support.  Common reasons for support buyouts include:

  • Disentanglement.  One or both people may prefer to be completely disentangled from each other.  If people are exchanging monthly payments, it means that they remain connected financially to one another for as long as support payments are owed.
  • Finality.  Spousal support buyouts are non-modifiable whereas monthly support payments are modifiable.  If you do a complete support buyout, you know that you will never have to deal with modifications in the future.  If you do a partial support buyout, it’s still possible that support could be modified.
  • Not Enough Cashflow. Sometimes the person who owes support does not have enough cash in their budget to pay support (but they still have a support obligation).  An example would be if there is a high earner who would normally owe spousal support but who takes on a substantial amount of debt and therefore does not cash to pay support.  One way of addressing this is to do a full or partial support buyout.

Are there any other considerations?

Spousal support buyouts are technically property transfers instead of spousal support payments.  This means that the transfer is not a taxable event, i.e., the person transferring the buyout does not get to write off the transfer on their taxes and the person receiving it does not pay taxes on the transfer.  This is something that is typically very appealing from the recipient’s perspective.

To make a buyout work, though, there (obviously) must be enough assets to do it.  It’s often the case that one or both people prefer a buyout but there simply are not enough assets to make it feasible.  For example, if someone would normally owe $1,500 for 10 years, the recipient presumably is not going to agree to accept $20,000 in extra 401K assets in exchange for waiving monthly support payments.

How do partial buyouts work?

A partial support buyout can be used to reduce the amount of support owed or the duration of support owed (or both).  For example, if someone owed $2,000 per month but could only afford $1,000 per month, the agreement might be that the support recipient receives $1,000 per month but also receives more retirement or home equity to “make up” for the other $1,000.

One scenario where partial support buyouts are frequently used is when support would be “indefinite” but both parties want to make sure they are not financially connected indefinitely.  The agreement might be that support is paid until the payor retires, and instead of paying a reduced amount indefinitely, the parties decide that the recipient will receive extra assets right now to “buy out” the indefinite component of the support award.  For example, someone might pay spousal support until age 65 but transfer extra retirement or home equity right now so that support terminates at 65.

Warning: If you are doing a partial support buyout, it is very important that your judgment is very specific about how the buyout limits (or does not limit) future modifications.  For example, if someone paid a lump sum of cash to “buy out” the last 5 years of support, they would not want to end up in a situation where support ended up getting modified and the duration of support lengthened.  You can protect against this by making sure that the duration of support is non-modifiable but amount of support remains modifiable.

Are there any risks to a spousal support buyout?

The main risk to a support buyout is the fact that a support buyout is not modifiable (whereas spousal support payments are modifiable).  For example, if someone were paying monthly support payments and lost his or her job, that person could probably get the spousal support reduced (at least until they got a new job).  Since support buyouts cannot be modified, if that person transferred $100,000 in extra 401K as a support buyout and then lost their job, the support buyout could not be modified and there would be no getting the buyout back.  Another example is that if the support recipient gets remarried, it is possible (although not guaranteed) that support could be reduced or terminated.  If there had been a buyout, the buyout is final and cannot be changed even if they recipient gets remarried.

Another “risk” of support buyouts from the payor’s perspective is that he or she uses most or all their assets to fund the buyout and then is left with very few assets.  (Related to this, it’s possible that the payor just doesn’t have enough “extra” assets to do a buyout.)  This is a calculated risk by the payor, but it’s a risk nonetheless.

How do you calculate a support buyout?

To calculate a support buyout, we start by looking at how much monthly support payments would normally be if there were going to be monthly payments.  (Sometimes people will just decide on an arrangement they think makes sense without going through this analysis, but people typically go through this analysis.)

After you determine what support payments would normally be, we total the amount of all payments and then make two reductions to the total amount.  The first reduction is to account for the fact that the support recipient pays taxes on monthly spousal support but does not pay taxes on the support buyout.  For example, if the total payments were $48,000 over 4 years, the recipient might pay $12,000 in taxes on those payments and therefore the actual “value” to the recipient is $36,000.  This means that $36,000 cash is worth the same as $48,000 in monthly payments since you must pay taxes on the monthly payments but not the buyout.

The second reduction is for something called “present value”.  The basic idea behind present value is that a dollar today is worth more than a dollar received at some time in the future.  For example, would you rather have a $1,000 today or $1,000 five years from now?  Why?  There are several reasons, but the two main reasons are that if you invest $1,000 now it will be worth much more in 5 years (hopefully).  The other reason is that inflation will erode the value of money over time, so $1,000 buys more today than $1,000 will buy in the future.  An example of this is that a new car used to cost $3,000.  Today, the same type of car might cost $30,000.  That’s the result of inflation (amongst other things).

So, in the above example, if you received say, $32,000 today, it might be worth the same as $36,000 paid over 4 years.  Again, the reason why is that 1) you can invest the $32,000 over 4 years to (hopefully) end up at $36,000, and 2) it costs less today to buy goods then it will cost to buy the same goods in the future.

So to summarize the above example, $1,000 per month in spousal support for 48 months is basically the same thing as receiving $32,000 today.   This is only an example!  Round numbers have been used for simplicity.  The numbers are generally in the ballpark, but these should not be relied on as “accurate” buyout numbers. 

So now what?

This is a complicated topic, so don’t worry if it doesn’t totally make sense!  If you think that a support buyout might make sense in your situation, you should discuss it with your spouse and see if it is something he or she is open to.  Your mediator, lawyer or financial professional is available to help you do the analysis and you should not feel like you need to get it figured out yourself.

Creating Budgets in the Divorce Process

In the traditional divorce process there is a lot of haggling back and forth about the amount of spousal support that will be paid. We take a different approach in the mediation and Collaborative Law context. In both of these processes we attempt to arrive at a meaningful support arrangement – one that compares need versus ability to pay and seeks to make sure everyone can pay their bills after the divorce. Budgets are instrumental in determining spousal support awards in both mediated and Collaborative divorces.

You have probably heard of budgets before although you may not have ever done one. In short, a budget is simply the total of all the money coming in and all the money going out. Here is a Monthly Budget Form for your convenience. Although this form is fairly comprehensive, you can certainly add to it.

Here are a few things to think about when you are preparing your budget:

Apples to apples budgets. It is important that both people use the same level of budget. They do not need to use the same amounts in their budget, but they do need to be including (or excluding) the same types of expenditures. For example, if one person includes a travel line item in their budget, then the other person should as well. If someone includes voluntary retirement in their budget, then so should the other person. However, the amounts don’t need to be the same. For example, it’s not unusual that one person has a much higher grooming budget than the other. The bottom line is that if someone is using a minimalistic budget, the other person should as well. If someone is using their preferred budget, so should the other person.

Exchange budgets before the meeting. You should exchange your budgets with each other before the meeting in which you will be addressing support. Neither person has veto power over the other person’s budget, but it is perfectly fair to comment on the other person’s budget. Often times people overlook or underestimate certain expenses; having the other person review your budget may help identify these things. Similarly, sometimes people overestimate costs and it fair to point that out as well. The purpose of exchanging budgets before the meeting is so that both people can offer feedback prior to the meeting. You want to go into the meeting with both people satisfied that the other person’s budget is reasonable. Two hour appointments aren’t cheap – you don’t want to spend the meeting arguing about budgets! Instead, you should come into the meeting having already reviewed and commented on the other person’s budget so that you can spend your time actually discussing support rather than arguing about whether someone should have included lawn service in their budget.

One-time expenses. Expenses such as your mortgage or cell phone are easy to identify. What are more difficult are one-time expenses. For example, you only need new tires every three or four years, but when you do they may cost $600 to $800. Similarly, Christmas only comes around once per year, but if you don’t budget for it you could end up with a huge credit card bill. It’s therefore important to think about these one time or irregular expenditures when preparing your budget.

Use post-divorce budgets. Many times people are still living together while they go through the divorce process and don’t have any idea how much life will cost after the divorce. Although this is somewhat challenging, it is very important to try to accurately project what your budget will be after the divorce is final. For example, if you will be moving, try to figure out what part of town you are moving to and how large a place you are looking for. This will give you some idea about what your rent will be and it will also help you begin thinking about the total cost of your utilities. Sometimes people decide that it makes sense to create two budgets – one based on current expenses and one based on their expenses after they move out.

Budgets can be challenging – particularly if you are not used to doing one. However, they are very important in determining an appropriate support award. Since budgets usually take some time to figure out, you should probably start working on your budget sooner rather than later…you will be glad you did!