One shortcoming of the family law system in the division of marital assets is that all assets that fit within the “pot” for equitable distribution in the event of a divorce are assigned a fixed value and treated equally (including retirement assets and current assets).
Retirement savings are some of the largest assets subject to equitable distribution, yet they serve a very different purpose than current assets like a checking account. Thus, prior to dividing the marital estate, it’s essential to understand your financial needs for your post-divorce life and ensure you are acquiring the necessary assets for such purpose.
When it comes to retirement assets, there are two types of retirement plans available: (1) Defined Contribution Plans, (i.e., 401(k)’s, 403(b)’s, IRA’s, 457’s, TSP’s); and (2) Defined Benefit Plans, (traditionally known as Pension plans). Both types of plans are “defined” because the employer and employee “know” the benefits available when the plan becomes payable; yet there are some important difference between these two types of retirement plans for divorce purposes.
For Defined Contribution Plans, whatever the account balance is at any given time is the account’s value at such time. Statements are often provided on a periodic basis reflecting the available “pre-tax cash balance” for the participant, which makes it easy to understand the amount available for division purposes. The division of such a plan can be made either by way of (1) “rollover,” which rolls-over a portion of / all of the account balance into the other spouse’s IRA; or (2) QDRO (qualified domestic relation order), which order directs the plan administrator to transfer a specified amount into the other spouse’s IRA account. Both methods (rollover and QDRO) will not impose a tax consequence on either spouse so long as the division is done as part of the divorce agreement. Regardless of the method employed, the divorce agreement should state whether the former spouse is sharing in the growth / loss of the plan’s balance between the date of divorce complaint and actual date of distribution or whether all such growth / loss remains with the titled spouse alone.
For Defined Benefit Plans, the future monthly benefit is determined by a specific formula or calculator provided by the employer. Defined benefit plans for a non-retired participant will generally be a bit more difficult to value for division purposes. Such plans will usually only provide:
(1) A monthly benefit estimate, which tells what the participant’s accrued benefit will be based on varying factors (usually based off of the individual participant);
(2) A statement of contributions, which shows the participants contributions to the plan but is generally not in any way an accurate valuation of the plan; or
(3) Nothing at all (government plans are not subject to ERISA and therefore do not necessarily provide regular benefit estimates).
So how do you value a defined benefit (pension) plan? The answer depends on your objective:
- (1) A simple division of the marital portion equally; or
- (2) Value the plan for offset (so that the overall marital pot is divided equitably rather than dividing each marital asset individually).
If you simply want to divide the marital portion of the defined benefit plan equally, then you need only spell out: (1) the percentage that you wish to assign (or coverture formula); (2) the dates of valuation for the same; and (3) any ancillary economic benefits, if available (such as survivorship, COLA, early retirement subsidies/supplements, etc.). For example, 50% of the future monthly benefit, or 50% times a true or frozen coverture fraction.
Keep in mind, however, that usually any benefit estimate is based solely on the life expectancy of the participant. This means that any monthly payment amounts in the estimate may change if a separate interest is applied to the benefit assigned, (i.e. the valuation is no longer based on the life-expectancy of the participant but rather is now based on a new interest – such as the other spouse’s life-expectancy).
If you want to value the plan for offset, then you will need a Present Value Calculation (an estimation of how much money is needed today to fund a future stream of annuity in consideration of prevailing interest rates, mortality rates, and the time between valuation date and date of retirement). To perform a present value calculation, you would use the plan’s benefit estimate that values the plan as of the date of normal retirement, and convert such value into a lump-sum present value. If no benefit estimate is available, then you must hire a valuation expert to create such a benefit estimate.
Caution, however, should be taken when considering employment of a present value because of the shortcoming in how the family system treats all assets that fit within the pot for equitable distribution. A future stream of income reduced to a dollar value is hardly the same thing as a checking account valued at the same dollar amount; yet both assets are treated equally for division purposes. Obtaining a present value and utilizing it in court / settlement discussion should be reserved for a few limited instances, because it may accidentally put you in a position that you do not actually want to take.
So when should you use a present value calculation? The only times that these sorts of offsets are worthwhile are either when:
- (1) A plan is not divisible by QDRO or QDRO-like order, thereby adding collection and tax issues that would potentially reduce the value of the asset; and/or
- (2) There are sufficient assets such that offsetting the pension will not do a financial inequity to the participant.