In a divorce situation, many couples and the professionals supporting them look only at the current list of assets and debts the couple has acquired. This isn’t necessarily a fair and true look at where a couple was heading in their combined future, and now that a divorce is happening where they each can continue to head in their separate futures. Because a traditional balance sheet looks at a specific point in time rather than over an entire lifecycle it really leaves a lot to be desired in analyzing the impact that a divorce or really any major life change (e.g. keeping your house, buying a bigger house, or retiring) will have on both people’s living standards.
So how does a lifetime balance sheet work?
At the highest level:
Lifetime Assets – Lifetime Committed Spending = Living Standard Support
- Lifetime Assets include things that you accumulate through life like:
- Non-retirement Savings
- Retirement Savings
- Earnings – This is the ability to work and earn income
- Social Security
- Lifetime Committed Spending includes things that you have to pay like:
- Housing Expenses
- Federal & State Taxes
- Insurance and Special Expenses (e.g. college savings for kids, a car)
- Living Standard is what is left after you earn, save, accumulate and then pay the mandatory things. This is the money you have to live your daily life on.
What does this look like for a couple or individual?
In general, here’s how the process plays out over a lifetime:
- You have little, if any, financial assets when you start your working life.
- You then begin to work (using your human capital) and earn an income.
- Much of this income goes to pre-retirement consumption spending and other goals. The rest is saved as financial assets.
- As time goes on, you hopefully grow your income (human capital) while ideally keeping your pre-retirement consumption spending as low as possible. This allows you to put more and more into your financial assets. Also, you are growing an often-overlooked financial asset in the form of Social Security.
- When you retire fully you are left with your Lifetime Assets and your remaining liabilities (i.e. retirement life spending). Your goal is to have your assets be greater than your estimated retirement living standard for your estimated life expectancy.
Can a divorce change the lifetime balance sheet?
ABSOLUTELY! Using the lifetime balance sheet modeling technique to look at the couple now as two separate individuals, based on proposed settlement agreements, allows them to understand better the sustainable living standard for each person and envision the long-term impact of these critical settlement decisions, particularly in deciding things like should one party keep the house, should one take more retirement in lieu of something else.
Adding a lifetime balance sheet analysis to the divorce settlement negotiations provides really valuable insights into decisions being made that would otherwise be hidden on a traditional balance sheet.
