Rising inflation has come to dominate the news, and you may notice its effects as you pay higher prices at the gas pump and the grocery store. You may not have realized, however, that inflation could also affect your divorce. (In fact, it may even increase your chances of getting a divorce according to one research paper.)
Though inflation is a big news story at the moment, it is actually always with us, slowly chipping away at the value of our money. Oftentimes, inflation is overlooked during divorce settlement negotiations, which can be a very costly mistake. So, let’s consider how inflation impacts divorce and what you should do to inflation-proof your divorce.
What Is Inflation?
The price at the pump has increased $0.10 a gallon over the past week. A gallon of milk rings up for $0.20 more than it did last month. Suddenly, there seems to be less cereal in the box you open even though the price is the same.
These are all the effects of inflation, which, Investopedia defines as “the decline of purchasing power of a given currency over time.” In other words, the higher inflation goes, the less your dollar will be able to buy. These effects of inflation may be easy to see at the grocery store, but how does inflation impact divorce?
How Inflation Impacts Divorce
Though inflation is typically associated with negative factors, like the rise of food prices and college costs, it isn’t inherently bad or good. In some cases, rising inflation can lead to increased wealth if you own the right types of assets. This is why it’s so important to understand how inflation could impact your divorce. While inflation may slowly lower the value of one spouse’s settlement, it could also raise the value of the other spouse’s settlement over time. By taking inflation into consideration as you negotiate your settlement, you can ensure that both spouses really do come away with a fair share.
The Value of Tangible Assets Usually Goes Up
Just as inflation raises the price of gas at the pump, it can also raise the value of the things you own, including the value of your home and stocks. The spouse who keeps the home and comes away with a strong investment and/or retirement portfolio is likely to see their financial position strengthened over time due to inflation. Think about it. In the long run, the stock market has, historically, produced positive returns. The same is true of a majority of the housing market. This means that receiving assets in the divorce could be more valuable than they originally seemed.
The Value of Maintenance Awards Will Go Down
The amount you receive in child support and/or alimony (also known as spousal support) will gradually buy less and less over time. This is because as inflation causes prices all around you to rise, you’ll receive the same amount in monthly maintenance. What happens when your landlord increases your rent, your electric bill goes up, and your grocery bill costs more and more even though you buy the same things?
Spouses receiving maintenance awards must understand that what might seem like a sufficient amount of money today may not be enough to help them cover their expenses over the course of a decade or more.
Large Expenses Will Go Up
Before you can begin negotiating a divorce settlement with your spouse, you need to put together a personal budget and predict how much you’ll need for large expenses. How much will you need to retire on time? How much will it cost to put your children through college? Do you want to come away from the divorce with enough money to go on vacation each year and to upgrade your car every five years? These purchases need to be a part of your divorce settlement calculations.
You absolutely must add inflation to this equation since the cost of all these expenses will continue to rise each year. Note that the cost of tuition and fees at private universities rose 144% from 2001 to 2021. If you are negotiating the cost of college for your young children based on today’s pricing, you could be woefully underfunded by the time your kids graduate high school. The same is true of your retirement needs. By not taking inflation into consideration, you may not be able to retire on time.
How to Inflation-Proof Your Divorce Settlement
Unless you own a crystal ball, there isn’t actually a way to completely inflation-proof your divorce settlement. There’s just no way of knowing how much inflation will affect the prices of assets, goods, and services in the future. However, just by including inflation estimates in your calculations, you can put yourself on much stronger financial footing. Here are a few ways to do that.
Add a Cost-of-Living Provision to Your Maintenance Award
One of the best ways to ensure your child support and/or spousal support payments will continue to cover your costs over time is to add a cost-of-living provision to your settlement. This provision (also known as an “escalation clause”), ties your maintenance award to the inflation rate and will automatically increase your award as inflation rises.
Some states already include a cost-of-living provision into maintenance awards. If your state does not, you can request it as part of your divorce settlement negotiations.
Work with a Financial Specialist
Perhaps the most powerful thing you can do to ensure inflation doesn’t erode your divorce settlement is to work with a financial specialist, such as a Certified Divorce Financial Analyst, who can make inflation calculations for you. It can be difficult for a layperson to figure out how much money they’ll really need to maintain their standard of living over the next 30 years or to determine how much they’ll need to retire on time. A financial advisor can come up with these numbers for you.
Your advisor can also help you predict how the value of your assets, like your home and investment accounts, will change over time. Ultimately, with their help, you can negotiate a stronger divorce settlement that won’t leave you cash strapped in a decade while your spouse’s share of the settlement has increased in value by leaps and bounds.
Balance Assets with Maintenance Awards
Let’s say your spouse wants to keep your home, which is currently worth $500,000. They offer to pay you spousal support in the amount of $4,250 a month for 10 years. Add that up, and it amounts to $510,000. Sounds like a good deal, right? By now, you should know that there’s a lot more to the story. From 2009 to 2019, housing prices increased 35%. In a decade, your spouse’s home could be worth $675,000, while a 3% increase in inflation per year would mean your monthly $4,250 would now have the spending power of $2,975. Not a good deal at all!
When negotiating your divorce settlement, consider balancing assets that will likely increase in value over time with maintenance awards that will decrease in value over time. Another alternative is to ask for a higher amount of maintenance to cover the inevitable increase in inflation.
Invest Your Cash
One final option is to take a portion of the cash you receive from your divorce settlement and invest it in a balanced portfolio. This will help ensure that your money grows with or (hopefully) exceeds inflation. If possible, you’ll also want to invest a portion of your maintenance payments each month as well to help maintain its value. A financial advisor can help you devise an investment portfolio that meets your risk tolerance and helps you meet your financial goals.
Keep an Eye on Inflation
Now that you understand how inflation impacts divorce, you can take steps to inflation-proof your divorce settlement. Simply by including inflation calculations into your divorce settlement, you’ll help to ensure a much stronger financial future for yourself. You can also learn much more about which financial mistakes to avoid during divorce by attending our Second Saturday Divorce Workshop.