Although all economies go through cycles, our current economic situation is unusual.  In this particular situation, we had the “perfect storm” economically speaking.  People were in over their heads in credit card debt, their houses had second and even third mortgages, interest rates on debt were increasing, and the value of their homes was shrinking.  Add to this mix the unemployment rate rising, and business incomes dropping and the economy slid into a nasty recession.

Regardless of the economic situation, people will still get divorced.  How do people handle their debt situation, a house that is worth less than their mortgage, and a possibly lower income situation?  In addition to these money woes, what if they are also faced with a possible bankruptcy?

Bankruptcy and divorce become a dicey area.  Which should come first - the divorce or the bankruptcy? 

Let’s say that the divorce is final and your ex-spouse declares bankruptcy.  Even if the under the terms of the settlement agreement your ex is supposed to pay for certain debts, if he or she declares bankruptcy and your name is still on the debt, the creditors can still come after you. You could get stuck with the debt. You may be able to go after your ex in court, but only after the damage is done.  And – you may be able to get very little relief if he or she has very little income or property.  In this case you should consult an attorney. However, in addition to having the creditors hound you, your credit score could be adversely affected, resulting in higher interest rates, an inability to possibly refinance your house, or even to get credit.  To add insult to injury, if you have taken cash as a property settlement in lieu of other assets (such as a 40lK), you may be required to use the cash to pay the creditors.  You, too, may be forced to declare bankruptcy.

Before 2008, many bankruptcy attorneys used to generally tell clients to get divorced and then file for bankruptcy – because this way, the property settlement was firmed up, and clients would know what assets and debts they would receive.  Also, filing bankruptcy after the divorce is initiated, but before the divorce is final, only halts the divorce process until the bankruptcy is settled.  However, economic times have become so tough that many bankruptcy attorneys are now telling clients to declare bankruptcy and then file for divorce after the bankruptcy is settled.  Moreover, if couples file bankruptcy together, they can save the additional cost of another separate bankruptcy filing. 

There are generally two types of personal bankruptcy, and they depend on a number of factors and depend on the size and type of debt, income, etc. 

In a Section 7 bankruptcy, most debts are erased, but there are lower income limits for people to qualify.  In a Section 13 the debtor is put on a repayment plan and a very tight budget.  People with higher incomes are usually placed in this type of bankruptcy program. 

Seeing an experienced bankruptcy attorney before the divorce can help avoid numerous problems.  For example, a client with struggling business was taking money out of his IRAs to fund living and business expenses.  He was also taking a salary from his business.  Not only were taxes and penalties incurred for the early withdrawal of funds from his IRA, but he was being taxed on his salary as well.  Because of withdrawals from IRA, and his salary, he was making too much money to qualify for a Section 7 bankruptcy, which meant that his debt would not have been dismissible.  He would have had to file a Chapter 13 bankruptcy, whereby he would be on a strict repayment plan.  Not only did he create a large, unnecessary tax burden for himself and his ex-spouse, but he depleted an asset that didn’t need to be depleted – his IRA.  Remember - IRAs are generally protected from bankruptcies up to one million dollars.   See a bankruptcy attorney before divorce – or before you withdraw funds from your IRA if you even have an inkling that you might be headed towards bankruptcy.

These days, bankruptcy and divorce often go hand in hand.  It is critical that couples in tough financial situations who are considering divorce, also consult divorce attorneys and financial specialists early in the process.  These professionals can help them with the timing of their divorce and potential liquidation of retirement assets.  To do otherwise can potentially lead to couples losing money that they can ill-afford to lose.