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Economist Laurence Kotlikoff, well known for his Ask Larry Social Security column and his best seller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security Benefits” (co-authored by our Paul Solman and Philip Moeller), advises people on their divorce settlements. For today’s column, he provides some advice on the finances of divorce.
Economists, as the old adage goes, know the price of everything but the value of nothing. There’s a reason. Economists spend years in a very special boot camp, called economics graduate school, where they have their hearts drained and their heads drilled. When it’s over they can think about any issue, including divorce, in purely objective terms with not a shred of emotion. So whether it’s buying kidneys, selling newborn babies, valuing sex “workers,” or leaving one’s spouse, economists have their pencils sharpened, their equations ready, and their hearts hardened.
“Objective divorce” is a phrase that would bat not a single eye in an economics seminar, but could well lead you, my un-brainwashed readers, to leave off the word oxy and just shout moron! So it is with some trepidation that I venture to talk about divorce purely on objective economics grounds.
I’m doing so because divorce is a terribly difficult financial decision that confronts huge numbers of you. Some 5,000 former U.S. lovebirds call it quits each day—one pair every 20 seconds.
So will your marriage make it for as long as you both shall live? The chances exceed 50-50, but not by much. What about second marriages? Sorry, they collapse at an even higher clip.
But what’s a fair deal? If we’re married for only ten minutes, fair surely means simply parting ways. But what about marriages that last a long time? In this case, fair may mean dividing assets and income so that each spouse has the same living standard (spending power) going forward.
This particular solution—equalizing the two spouses’ living standards—falls out of the economics math under some pretty general conditions, provided we view divorce as an insurance arrangement; that is, as a means by which each spouse insures the other against their long-term marriage breaking up.
Obviously, divorce means maintaining two residences and foregoing all the other economies of shared living (the fact that two can live more cheaply than one). So when I say a fair divorce to a long-term marriage entails the same living standard, I really mean the same reduced living standard. Interestingly, state alimony guidelines, where they exist, tend to produce more equal living standard outcomes the longer the marriage.
Clearly, other issues, like how much the two spouses work and who keeps the house enter into the fairness equation. But economists can make reasonable dollar adjustments for these factors.
The interesting question is how to calculate what’s needed to achieve living standard equality or some differential that both spouses feel is fair. The answer is via financial software that directly calculates your post-divorce living standard, taking into account all relevant factors, including future taxes and Social Security benefits.
An example is the ESPlannerBASIC software my company provides as a free public service. While the program is bare bones, anyone running it can get a pretty good sense of the living standard they and their spouse will each experience under any given divorce settlement.
Take, for example, a childless Massachusetts couple married for 20 years. The husband is 50 and earns $150,000. The wife, 45, earns $30,000. Both will retire at 65. He has a $500,000 401(k), she has a $50,000 IRA, and they jointly own a $400,000 house free and clear. They are cautious investors who expect to earn only 2 percent above inflation. And both think they could make it to 100.
Here’s my question. If they split the house and the assets, how much will the husband need to pay in alimony for the next 15 years to equalize their living standards going forward?
The husband thinks it’s $30,000 given the higher taxes he needs to pay. The wife has more years to go and knows she, not he, will pay taxes on the alimony. She’s sure she needs $90,000 a year for 15 years to live as well as him. They are about to pay two high-priced lawyers to duke it out. They needn’t. ESPlannerBASIC suggests $60,000 per year for 15 years is roughly the right figure.
OK, but what if the husband thinks his living standard should be 30 percent higher because he earns more. And what if his wife disagrees, pointing out that she put him through grad school and sacrificed her own career in the process?
Well, economics is not going to resolve this fairness dispute. But once the two do agree on a living standard differential, be it zero or positive, they don’t have to fight over what it takes to achieve that differential. Dull, heartless, modern, objective economic software can end that potentially ferocious and outrageously expensive argument in a matter of seconds.