What Happens to Your Investments in a Divorce?

When Adam began sorting through his finances after separating from his wife, he knew they would have to divide the wealth accumulated during their marriage. What he didn’t anticipate was how many different investment accounts and assets would come into play – or how much the settlement would cost.

The couple had the typical array of investment accounts: registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs), workplace pensions and registered education savings plans (RESPs) for their two young children. Adam, whose name we’ve changed for privacy, also had a non-registered portfolio.

After several meetings with lawyers, during which their combined assets were documented, valued, and run through an equalization calculation, Adam was surprised by the size of the payment he owed his former spouse.

“It was a big number when everything was calculated, and then figuring out how I was going to be in a position to make that payment, and, you know, the tax implications,” says Adam. “It felt like I was taking quite a haircut, and more than I had expected.”

Most people understand that property will be divided in a divorce, but investment assets, pensions and the related account types and taxes can add layers of complexity. Beyond the investments themselves, the income they generate through dividends, interest and other returns may also be considered when dividing assets and calculating support.

How are investments divided?

There’s a perception that every investment account will be sold and split equally when a marriage ends, but that’s not necessarily what happens, explains Anna-Marie Musson, founder and managing lawyer of M and Company Family Law in Toronto.

“We divide the value,” she says. “So, a person doesn’t necessarily need to do a spousal rollover for their RRSP or collapse their investments, which could create some significant tax issues.”

Instead, the process generally begins by identifying and valuing the couple’s assets and liabilities as of the separation date. That’s the date the relationship is considered to have ended, not necessarily when one spouse moves out or the divorce becomes final.

“The separation date is really that snapshot in time where you’re valuing all the assets and liabilities,” says Chantal McNeily, an investment and wealth advisor at RBC Wealth Management. Because joint accounts do not automatically freeze upon separation, any subsequent transactions and contributions must be recorded, she adds.

Exactly how that value is divided depends on the laws of the jurisdiction where the couple lives. In Ontario, for example, each spouse generally calculates the increase in their net worth during the marriage. The spouse whose wealth increased by more usually makes an equalization payment representing half the difference. One spouse might therefore retain a portfolio or pension while the other receives different property or a cash payment of equivalent value.

Why the account type matters

When a couple’s assets are being calculated, the type of investment account(s) each party has matters, because taxes and transfer rules can affect the ultimate value of each asset. For example, money withdrawn from an RRSP will generally be taxed, while money withdrawn from a TFSA will not. Transfer rules also vary depending on the account type.

RRSPs and locked-in retirement accounts may be included in the property calculation, although eligible transfers between former spouses can generally be completed without withdrawing the funds or triggering immediate tax.

TFSAs may also be included when property is divided, depending on provincial rules. However, TFSA contribution room belongs to the individual and cannot be transferred to a former spouse. If funds are withdrawn from one spouse’s TFSA and given to the other, the recipient typically needs to have enough contribution room to deposit them in their own TFSA without facing an overcontribution penalty. If money is transferred directly from one person’s TFSA into the other’s through the receiving financial institution, this will not affect either person’s contribution room, if all conditions (you and your spouse or common-law partner are living separate and apart at the time of the transfer, and the amount is transferred under a decree, order, or judgment of a competent tribunal, or under a written separation agreement) are met. Note that the transfer isn’t considered a withdrawal, so no contribution room will be added back in the following calendar year to the TFSA of the person making the transfer.

Non-registered portfolios bring a different complication: selling investments may trigger capital gains or losses. Depending on what’s held in those accounts and how they were funded, you could have two accounts with the same balance that have very different after-tax values. For instance, if an account contains larger unrealized gains, the after-tax value of that account could be significantly lower than one that is mostly cash. Those potential tax liabilities should be considered when deciding which spouse keeps each account or how much other property the other spouse receives.

How pensions are valued also depends on the type of plan. A defined-contribution pension has an identifiable account balance, while a defined benefit pension promises future retirement income and requires a formal valuation to determine its family law value. The value used for family law purposes may differ from the amount shown on an annual pension statement.

“A lot of couples undervalue a defined benefit pension,” says McNeily. “For example, if one spouse had a government pension and the other didn’t, that could be worth a significant amount, and they might be surprised at how much the payout is to equalize that pension.”

Adam and his former wife both had pensions that needed to be valued. Rather than dividing his pension, he kept it intact and made an equalization payment to his former wife. “I preferred to make the cash payment up front,” he says.

Tax consequences

One of the big questions for Adam was where the money for the equalization payment would come from.

After working with his financial advisor, he decided to give his ex-wife a lump sum to settle things quickly, paying with money from his non-registered assets. However, “there was capital gains tax when I liquidated some of the investments, so I got hit with that,” he says.

That’s a good lesson for those who may have to sell assets: the balance shown on a statement does not necessarily reflect what an asset will be worth after tax. “To raise enough cash for the equalization payment, the spouse with the higher net family property might sell other assets or take on debt,” says Musson. “Whatever we do, it’s through the lens of: ‘What tax implications would there be if we collapse this asset?’”

A financial advisor, an accountant and a family lawyer can work together to assess the alternatives before any sale or transfer takes place.

When investments produce income

Dividing the value of the investment property is only part of the equation as family law considers the income available to support the family, says Musson. That can include employment earnings as well as dividends, interest and other investment income. In some circumstances, income or pre-tax corporate income held inside one spouse’s business may also be considered.

“I think the point about investment income being income is very surprising for people when it comes to support,” says Musson.

This also creates a distinction between an asset and the income it generates. An inherited portfolio might be excluded from the property division, depending on the circumstances and provincial law, while investment income could still be relevant when support is calculated. Adam says dividends were his main source of investment income at the time of his divorce, and that this became part of the couple’s financial discussions.

Rebuilding your investment plan

Once Adam’s settlement was complete, he had to revisit his portfolio and long-term plan. Divorce can change the amount someone has invested, the income those investments produce and the level of risk they can afford. As a result, you may also need to reassess your goals, time horizon, asset allocation and retirement projections.

An individual’s expenses could also go up as a result of a divorce, because they may now have only one income supporting what’s often a similar lifestyle to the one they had during their marriage. During a divorce could be a good time to review account beneficiaries, insurance policies, wills and powers of attorney.

McNeily advises clients to create an emergency fund and not to rush into big commitments, like buying a new home or rebuilding their finances, while emotions are high and they’re still adjusting to their new situation. She also cautions: “[Be careful about] taking excess risk in your investment portfolio because you’re trying to make up for lost time. Instead, you might want to consider building back the consistency of regular contributions to TFSAs and investment accounts.”

You might not be thinking about your next relationship yet, but Musson says some people re-partner “pretty quickly” after a divorce. If the right person comes along, she says, “have conversations about marriage contracts (prenups) and cohabitation agreements, with the understanding that you don’t want to go through this whole process of dividing everything again.”

As for Adam, he has since remarried. His new spouse also went through a divorce, and both were keen to avoid repeating that experience. “We’ve done things entirely differently. We’re completely transparent with each other. We have prenups – the assets we had coming into the marriage, we would have if we left the marriage,” says Adam. “Of course, we hope we never have to, but when you get serious in a relationship, be upfront about where things would end up if you split. Put bookends around the part of your life that existed before you walked down the aisle.”