What Is the Economic Impact of Divorce on Households?

Divorce typically has a large financial impact on the majority of households. When couples separate, one household becomes two, and they must pay for housing, legal fees, and the division of long-term assets such as pensions and businesses. As a result, the overall financial position of both people can continue to be negatively affected long after the divorce process has been completed.

Divorce may be considered an economic issue in that it entails separating a single economic unit into two separate households; therefore, the economic efficiencies created through shared living arrangements are reduced, while the financial pressure of duplicated fixed costs, legal fees, and the redistribution of assets increases.

The purpose of this guide is to provide an overview of some of the main economic implications of divorce on a household's finances. Specifically, it describes where in general will a household experience the most financial pressure from a divorce, what assets carry the highest level of economic risk for the parties during a divorce, and how different economic factors will affect overall financial stability for each spouse after they separate.

Who Feels the Economic Impact of Divorce Most Acutely?

Divorce affects families of every socioeconomic background; however, the magnitude of the economic impact from divorce on families is dependent on a number of factors, including how assets and income are structured within a family.

Those who experience the greatest financial stress when going through a divorce include:

Homeowners forced to sell their home at a discount because the housing market is weak
Business owners who have most of their wealth tied up in illiquid businesses or businesses that are not publicly traded
Families that have a significant amount of pension wealth that needs to be valued by a qualified specialist
Families with two incomes that rely on shared financial arrangements
Parents with childcare responsibilities who need to make changes to their housing and income as a result of going through a divorce

If you have business equity, multiple properties in your name, or a pension that has significant value, contact Stowe Family Law to learn about how early access to specialised advice can help you maintain your financial stability during and after the divorce process.

Economies of Scale and the Cost of Separation

Following a divorce, one of the immediate economic impacts is that you lose household economies of scale. For example, when two individuals live together, they share the costs of housing, utilities, insurance, food, transportation, etc. Once separated, many of these fixed costs are now incurred for two households instead of one.

Even though both households may still generate the same total income, many couples find they have less to spend on necessities or luxuries after divorce because of increased costs associated with maintaining each household. Economists often describe this as a reduction in household efficiency arising from duplicated fixed costs. For example, one combined household generally consumes fewer resources per person than two separate households.

During the divorce process, the increased financial burden placed on both parties creates additional financial pressure at a time when the uncertainty and cost of the legal proceedings are already two factors adding to the financial strain of a divorce.

Additionally, as one begins to transition from a shared household to independent households, other short-term financial pressures or liquidity challenges may exist that impact an individual's decision-making with respect to their finances during the divorce process. Such challenges may arise from maintenance payments, temporary housing accommodations, the need for different homes, etc.

The Economic Weight of Property Division

Property is typically the most significant asset in many divorce settlements; how the property is divided or what happens to it after the divorce will greatly impact each spouse's long-term finances.

The housing market's condition at the time the parties agree to sell the property will play a critical role in how much equity the parties will have following its sale. A forced sale during a recession may reduce both parties' equity holdings in the home. In a declining real estate market, high interest rates and/or restricted lending practices may prevent either party from refinancing their mortgage or borrowing enough money to buy out the other spouse’s share of the property.

Delayed sales may also provide stability for the parties' children by allowing one party to continue living in their family home for a specified time, but will delay the parties' financial separation and create uncertainty for both parties regarding future maintenance obligations, the home equity, and both parties’ exposure to real estate market fluctuations.

In considering property division economically, it is important not only to determine the respective ownership of the property, but also to quantify the liquidity of the property; the respective borrowing capabilities of the parties involved; the opportunity costs related to the property divided between the parties; and the potential for long-term retention of wealth by the parties combined.

Pension Division and Long-Term Financial Stability

Many households have pensions as some of their most important assets, but they are often overlooked during divorces. A pension sharing order allows one spouse to receive part of another spouse's pension. However, the process for accurately valuing each spouse's pension is complex and particularly so for defined benefit plans and public sector pension schemes. These plans often provide a stream of income for years to come, and the total economic value of the benefits from these plans is often far greater than the current cash equivalent value of the plan if you were to withdraw the money today. By assuming that pension plans can be treated like residential real estate without obtaining expert advice, there will be significant inequities in the total dollar amount of retirement income that both spouses will receive.

Also, the long-term nature of pensions means that any mistakes made in the negotiation of settlements may not be apparent until many years have passed since your divorce. From an economic perspective, this situation demonstrates the difficulty of estimating future income streams when there is uncertainty surrounding inflation, life expectancy, and investment performance.

Business Assets and Illiquid Wealth

The process of divorce can become much more complicated when one or both spouses may lose ownership of a private business (entrepreneurial divorce). Unlike cash or publicly traded investments, the value of equity in a business is often illiquid and very difficult to estimate accurately. If you have a divorce that involves business equity, a forensic accountant, revenue analysis, and assumptions about the future earnings potential of the company may be needed to do a formal valuation of the business.

In some instances, business owners may appear wealthy on paper, but actually have very few liquid assets (cash and liquid investments) to pay for the settlement without needing to sell their business or disrupt the company.

Unvested shares, deferred compensation, and future equity arrangements can all create additional difficulties in negotiations. Whether these assets are part of the matrimonial estate must often be determined through careful legal and financial analysis.

From an economic standpoint, the key difference between privately held companies and publicly traded companies is the distinction between paper wealth and available liquidity; consequently, a high net worth does not provide any immediate financial flexibility.

The Direct Cost of Legal Proceedings

Legal proceedings themselves generate substantial economic costs.

The costs of legal advice (solicitors' fees), court fees, actuarial assessments, property valuations, and forensic accountancy services can pile up quickly, particularly in situations where there is a dispute that has become contested. As well as the direct costs associated with extended litigation, there are also indirect costs associated with stress, lost production, and delayed financial planning as a result of the time taken to go through the legal process.

Economists tend to refer to these costs as transaction costs - or more simply put, the costs of negotiating, enforcing, and settling a dispute within the legal framework.

Mediation and negotiation/directed settlement processes usually result in lower total transaction costs than would be encountered in fully contested litigation. Where there exists a cooperative element to come to an agreement without entering into lengthy court proceedings, there is likely to be a greater amount of wealth for the respective households once the dispute is resolved.

The Broader Economic Consequences of Divorce

Apart from its impact on the party going through the process, divorce will have an effect on the economy as a whole. The market for housing, patterns of purchasing goods and services, savings habits, preparing for retirement, and the participation levels of people in the workforce may all be changed by divorce.

Typically, wealth that was previously held in one single practical unit becomes divided. As a result of the separation, long-term accumulation of wealth is likely to decrease, and each individual will have a higher chance of being financially unstable, particularly when housing and childcare costs are high.

In most instances, how efficiently a parent makes financial decisions before, during, and after the divorce (through careful planning, reasonable valuations of property, and informed negotiations about the division of property) can determine the long-term financial impact on both former spouses.