It’s not everyday that a caller leaves the hosts of The Ramsey Show completely shocked, but that’s exactly what happened when Dave Ramsey and John Delony met Thomas from South Dakota.
Thomas, who is an active duty member of the military, called in to the show seeking advice after racking up about $57,000 in debt following his divorce. His debt includes about $37,000 on a truck that he purchased after the divorce, as well as roughly $18,000 in credit card debt (1).
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As he explained on the show, Thomas earns about $78,000 per year, contributing 60% of his earnings to investments, 40% to his TSP (Thrift Savings Plan), and 20% to education savings for his kids — though he may have made a mistake with the math on how he splits his income.
Thomas, 36, believes he can pay his debts off “pretty quickly,” though doing so would mean temporarily holding back on contributions to his TSP. And this is where things get tricky for Thomas; according to his divorce settlement, instead of giving his ex-wife half of his military pension, Thomas is set to give his ex half of his TSP at 67, which is full retirement age.
“I’ve still been contributing [to my TSP] because in my head I was like, ‘I’d rather make a little bit more money on the back end, versus stop contributing altogether and, out of spite, just not contribute because I don’t want her to get any,’” Thomas explained.
Shocked at what he had just heard, Ramsey sought clarification, asking Thomas if his ex will get half of his TSP now, or in 30 years when he turns 67. Thomas confirmed the latter, which didn’t appear to make much sense for Ramsey and Delony.
“No, wait a minute. That’s not possible,” said Ramsey. “This divorce isn’t final, is it?” After Thomas confirmed the divorce is indeed final, Ramsey was unequivocal in his assessment.
“That’s a horrible deal.”
‘You got the worst deal in the history of divorces’
As Thomas explained to Ramsey and Delony, the divorce lawyers presented him with several options for the settlement and told him giving half of his TSP to his wife at 67 was “the better of the deal.”
And once again, Ramsey didn’t mince words.
“Apparently, these lawyers didn’t take math class,” said Ramsey. “So, you need to get clarification because I don’t think you understand what really happened. Or, you got the worst deal in the history of divorces.”
“I’ve never heard of this deal,” said Delony in agreement. And before the hosts could offer Thomas any advice on how to tackle his debt, the conversation had shifted toward the caller’s unique divorce settlement.
“It is normal for you to transfer half of your TSP to her now,” said Ramsey. “That is a normal process in a divorce, and she can roll that into an IRA and have no taxes. It is very strange for her to get anything at age 67. Like, I’ve never heard of this in 35 years of doing what I do. That’s strange.”
Ramsey reiterated that it would be normal for Thomas’s ex to get half of his pension and half of his TSP, which currently has $166,000. “So, whatever $83,000 grows to at age 67, she should get. But she shouldn’t get half of everything you put in (the TSP) between now and then, because otherwise you would put in nothing between now and then.”
When Thomas confirmed his ex will get half of whatever his TSP is worth at age 67, Ramsey doubled down on his strategic advice.
“You don’t put another dime in it (the TSP). You’re done with that,” said Ramsey.
“You’ve got to go put money in a Roth IRA and you’ve got to put money in other stuff. But the TSP is off limits to you, because she’s going to take half of everything you put in there for the next … Good god. For 30 years, you’re going to contribute to her. No, thank you. You did the worst deal ever.”
Delony agreed, adding, “she has a 30-year claim on future earnings for you.”
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What happens to retirement savings plans after divorce?
Similar to a 401(k) for private-sector employees, Thomas’s TSP is a defined-contribution retirement savings plan for federal government employees and service members.
When a government employee contributes to a standard TSP, their contributions are made with pre-tax dollars, which means Thomas gets a tax break since his contributions effectively reduce his taxable income. However, Thomas will have to pay taxes on withdrawals in retirement on both his contributions and his earnings (2).
There is also the option to contribute to a Roth TSP, where after-tax contributions can be withdrawn tax-free in retirement.
When it comes to divorces, the division of assets will largely depend on the state that the separating couple lives in. If a couple going through a divorce lives in a state with community property laws, assets acquired during the marriage belong to the “marital community” and are divided equally.
In equitable distribution states, however, assets acquired during the marriage are divided based on fairness and not equality. In these states, a judge decides what’s fair by dividing marital property based on a list of factors that includes each spouse’s income, the length of the marriage and the needs of any children (3).
Funds that were contributed to retirement accounts or pensions during a marriage are considered marital property. When a married couple gets divorced, these funds can be divided without triggering taxes by a court order called a Qualified Domestic Relations Order. The process is different for IRAs, which are divided using a method called “transfer incident to divorce,” which is also tax-free.
According to Ramsey, a situation like Thomas’s — where assets are not evaluated and divided during the divorce proceeding — is extremely uncommon.
How to protect your assets from a divorce
A 2019 survey from Martindale-Nolo found the average cost of hiring a divorce lawyer was $11,300, while the median cost was $7,000 (4). But the costs of divorce are wide-ranging, and divorcees can be impacted by more than just lawyer fees and the division of assets.
For example, a divorce will typically have an impact on the net worth of both parties involved, and especially the wife. One study found women’s household income dropped 41% on average after a divorce, which was nearly double the hit to men’s household income, according to the U.S. Government Accountability Office (5).
Divorce can be financially devastating, and that’s why it’s important to have a discussion about the worst-case scenario before getting married. While this may not be an easy discussion to have, talking with your partner about finances and what would happen in the event of a divorce before tying the knot can be a lifesaver.
In fact, this discussion may even lead you to discover that you and your partner have very different expectations, or that your viewpoints are even closer than you expected. Either way, a conversation like this can open the door to discussing a potential prenuptial agreement, which can keep your assets safe if the marriage were to go sideways.
If you’re like Thomas and you find yourself trying to get your finances back on track after a divorce, one of the first steps you may need to take is realizing that your lifestyle might have to adjust. For example, a divorced man such as Thomas may not be able to afford certain luxuries like a brand new truck, which has given Thomas a sizable chunk of debt that he now has to pay off.
“You cannot afford to drive this truck,” Ramsey told Thomas. “It’s more truck than you can afford with the money you make. Sell your truck. Get your budget back balanced and move into the future.”
“And please,” Ramsey implored, “don’t put anything else in this TSP.”
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Article sources
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The Ramsey Show Highlights (1); Investopedia (2); Justia (3); Martindale-Nolo (4); Government Accountability Office (5)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.