It’s a horrible truth, but some people’s spouses are so mired in debt that divorce starts to seem like the only way out.
Spouses aren’t responsible for each other’s premarital debt, and credit reports are listed for individuals, not for married couples, but many people bring a certain amount of financial baggage to a marriage, says Cate Williams, vice president of financial literacy at Money Management International, a nonprofit credit counseling firm in Chicago. And more baggage may be brought after the nuptials as well.
“It will impact you because some of your money will end up being diverted in one way or another to pay those bills,” Williams says. “It’s going to require resources, whether it’s his, hers or ours.”
How to separate assets
While complete protection from a spouse’s financial affairs might not be possible, spouses do have some ways to cordon off their assets, says Alicia Rinaldi, a family law attorney with Rinaldi & Sparks in Boston.
“You’ll probably have to use a combination of methods, and you may not be entirely insulated from the issue, but you can put up roadblocks,” she says.
The best roadblock is a prenuptial agreement that specifies who owns what. But for couples who skipped that step or overlooked some key issues, some states now recognize a post-marital agreement, which covers the same ground as a “prenup,” but is signed during the marriage.
Another approach is to lock up assets in accounts that may be harder for creditors to seize. Examples include certain retirement plans, trusts, partnerships or corporations, annuities or life insurance products. These strategies should be discussed with a trusted financial adviser or attorney to make sure they’re set up properly to achieve the desired goals.
Creditors may ignore roadblocks
None of those solutions works perfectly well, however.
One caveat of a pre- or post-marital agreement is that the couple must follow through and make sure the accounts designated as separate in the agreement are in fact held separately. (State community property laws may complicate this issue.)
“You can’t designate something as a separate account and then not have the actual ownership of that account reflect that,” Rinaldi explains.
A second caveat is that creditors aren’t a party to a marital agreement. That means they may still try to collect debts from either spouse, and the spouse whose assets are claimed contrary to the agreement may have to resort to legal action against the debtor spouse to enforce the terms. That could get ugly, and usually occurs only when spouses have decided to divorce, Rinaldi says.
A trust, corporation or the like also might not be “an absolute bar” against a creditor, Rinaldi says, but could be a deterrent to collection.
“It can make the process more difficult for the creditor, and maybe the decision will be not to go forward,” she says.
Divorce may not solve problems
Nor is divorce a surefire way to escape a spouse’s debts.
Rinaldi and Williams say they’ve heard of people who divorced due to debt problems, but that step usually happens not because of the debts, but due to a breakdown in communication and trust.
One reason debt rarely leads to divorce may be that, as Williams says, it’s often more expensive for ex-spouses to maintain separate households than to stay together. That makes the debt problem harder to resolve.
Savers and spenders must communicate well
Any strategy depends on good communication to be successful, Williams says.
But still, the “saver” in the marriage shouldn’t offer up savings to pay off the debts incurred by the “spender” because if the debts are too easily paid off, the spender is likely to be in debt again within a matter of months, she says.
Williams understands the reasoning behind paying off a spouse’s debt, but maintains that it’s important for the “spender” spouse to become financially savvy on his or her own.
“The debt is at 18 percent and your savings account or deposit certificate isn’t even giving you a toaster, but there needs to be some discipline exercised by the debtor to diligently at least pay the debt down,” she says.
Two exceptions might be medical bills or legal fees to resolve a child custody situation.
Another tip: The saver should try not to assume a dictator-like control of the spender’s activities.
“There doesn’t have to be a shift in power,” Williams says.