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Debt & Divorce – How To Handle It
July 8th, 2019 by Janet Doyle
Finances have a huge impact on relationships and our findings show that debt stress can lead to a marital breakdown. Unfortunately, divorce is often costly in itself, and causes more conflict as assets, debts, and finances need to be separated. Aside from the direct impact to finances, the separation of households becomes expensive with moving costs, new living arrangements, furnishings, and establishing separate lives. Then there is the potential of excessive legal costs associated with processing the finalization of the divorce, which could increase the debt load for both spouses substantially.
Sometimes the money issues that were pre-existing caused the breakup and sometimes the breakup caused the money issues; however, in both cases it’s important to know how to handle the messy task of untangling joint finances, especially if there is debt involved.
The process of a separation or a divorce requires the creation of a financial balance sheet for the relationship and it’s the perfect time to assess your personal future and make the right choice for your new life.
If you’re beginning the process of going through a divorce, ensure you use your own bank account and credit card and limit any joint financial involvement (like a co-signed loan, credit card, or joint bank account). Ensure that any joint financial arrangements you have are limited in their ability to take on additional debt and that you are required to be a signatory on any changes to current arrangements. Ideally you and your partner should destroy any joint credit cards or close joint accounts to ensure financial independence. Check your credit report to ensure you’ve covered all joint accounts.
While a separation or divorce agreement covers the agreement for paying back joint debts, it does not legally release a spouse from their obligation to repay the debt to the lender. If one spouse stops making debt payments or files for bankruptcy, any joint debtor is responsible for repayment, even after a separation. If you decide to continue paying the debts independently, ask the bank to split the loan into two separate accounts to move forward independently and ensure you protect yourself from any additional debt or financial misstep made by your ex-partner. If you decide to file for bankruptcy or a consumer proposal, the other spouse becomes responsible for 100% of the outstanding joint debt.
Typically, family property is considered everything you or your spouse own on the date of separation, including the family home, land, houses or condos, RRSP’s, investments, bank accounts, insurance policies, pensions, and businesses. Any property owned prior to living with your spouse is excluded. However, if the value of the property increases during the relationship, the increased amount may be considered part of the family property and the value is to be divided equally at separation. Additionally, any gifts or inheritance received by one spouse are excluded unless it was subsequently mixed with other assets (such as using it towards an investment in joint property).
How your assets are treated depends on whether you get divorced or file insolvency first. If the divorce happened before an insolvency and assets were transferred to your one spouse, those assets won’t be included in the bankruptcy, assuming the transfer was not fraudulent.
If insolvency is filed before a divorce or separation is complete, then all assets registered in your name (including 50% of the value of joint assets) will be included as part of the process, and specific rules apply that will determine which are exempt from seizure.
Alimony and Child Support
Payments to support an ex spouse or children are usually negotiated as part of a separation or set by a court order. If the payments are not made, the courts can garnishee your wages up to a maximum of 50% of your pay. Current and arrears of alimony and support payments are not included in an insolvency proceeding, but if the debt is overwhelming, it’s a good idea to see a Licensed Insolvency Trustee to learn about your options to deal with other debt payments. Spousal support payments are taxable to recipients and deductible by the payors; this should be discussed prior to the finalization of the separation agreement, and the spouse receiving support should prepare to pay taxes or set up quarterly installment payments. Child support is not taxable.
When a relationship ends, spouses can ask to split their Canadian Pension Pan (CPP) credits. CPP credits earned during the relationship can be combined and then split equally between two people. You’ll need to wait for 1 year to request the division of credits; and common-law relationships have 4 years to make a claim, whereas separated and divorced spouses have no time limit.
Transfer of Capital Property
When coming to an agreement regarding the division of property, tax implications need to be taken into consideration if a property is transferred from one spouse to another. If the house is maintained as the principal residence, capital gains at a later date will not be an issue. However, if the property is not maintained as the principal residence, the spouse who receives the property may be subject to capital gains on any increase in value after the date of transfer. One item to note is the CRA’s “Attribution Rule” which is designed to avoid spouses avoiding taxes by transferring property; this could result in the spouse that transfers the property being taxed on capital gains. Although it’s usually assumed that the recipient is responsible for any capital gains, it’s recommended to sign a document that assigns capital gains to the recipient.
Transfer of RRSP/RRIF/TFSA
The division of RRSP or RRIF as part of equalization between spouses is a preferable way of satisfying obligations when there is a large difference between marginal tax rates of spouses, especially if one spouse intends to draw income from the portfolio at a future time. Transfers can take place when the transfer remains in an RRSP of the recipient and there is a court order or separation agreement using CRA form T2220. TFSA accumulations can be split tax free and transferred to the other spouse’s TFSA.
Expenses for children can only be claimed by one parent, so it’s best to discuss this up front as part of the separation agreement. Typically the parent with primary custody claims credits for dependants, but you may want to look at alternate arrangements based on the marginal tax rate for each spouse.
- Child Care Benefit
- Tuition and Education Credit
- Children’s Fitness Amount
It might be the last thing you’re thinking about, but as you navigate your financial separation it is wise to update your will to match your new reality. After finalizing your separation agreement, talk to your lawyer about the best way to go about updating your will and estate planning.
Separation and divorce can be a challenging time to work together, but it is important to work with your former spouse to go over the impact of a divorce to your mutual financial health and try to minimize the damage. We suggest taking the following steps to ensure you minimize liability and provide a fresh, independent start to your new life:
- Obtain a copy of your credit report to review joint accounts and debts.
- Write to your creditors to inform them you’ve separated from your spouse
- Cancel any credit cards that are tied to your former spouse.
- Talk to your bank about joint accounts and how to protect the money while you financially separate.
- Cut down limits on overdrafts and credit lines and request that the accounts be changed to require two signatures for withdrawals.
If you or your spouse are overwhelmed with debt as you approach a divorce, talk to a Licensed Insolvency Trustee at Doyle Salewski to learn the best avenue to manage you debt as you embark on this new chapter. Contact Doyle Salewski to book a free consultation for yourself and your partner.