In the first of a series on Dividing Assets during a Divorce, Cardan Founding Partner Sarah Keys, explores considerations for dividing defined benefit plans.
Although not as prevalent as they once were, defined benefit plans can still be a significant source of retirement income for some individuals. As such, they should be examined closely in the context of a divorce settlement. This is particularly true if the spouse is still working and accumulating a benefit, payable at a future date. To clarify, a defined benefit plan, also known as a traditional pension plan, provides a defined monthly payment to an employee at retirement.
A defined benefit plan should not be confused with a defined contribution plan which is a tax deferred account in which the employee makes regular contributions and is responsible for investing the funds for use during retirement. It has a current value and the employee receives monthly or quarterly statements; the contribution amount is defined, not the future stream of income. The most common example of a defined contribution plan is a 401k.
There are three methods generally used to divide the defined benefit plan in the context of divorce:
- the present value or cash out method—the non-employee spouse is paid a lump sum settlement upon divorce from the pension or a marital asset of equal value;
- deferred division or future share method—the parties do not calculate a current value, but instead agree to a future split of the benefit when payable at retirement; or
- reserved jurisdiction—the court reserves jurisdiction to determine the payout at some future point. This is the least attractive, as the parties cannot properly plan for an income stream in the future that is unknown.
There are additional considerations when considering a pension division method;
- Will the employee spouse still be working and the benefit growing after the divorce?
- Was the employee spouse working before the marriage?
- Is there a cost of living increase calculated into the pension amount?
- What does the pension allow—can the non-employee spouse take benefits before the employee spouse retires?
- What if the employee ex- spouse gets remarried?
- Is there a risk that the working spouse could refuse to retire and delay payment to the ex-spouse?
All of these considerations must be addressed with the pension plan administrator and clearly laid out in the divorce settlement and a Qualified Domestic Relations Order (“QDRO”). A QDRO lays out the agreement between the parties and instructs the plan administrator as to how the benefit is to be divided between the parties. A person specializing in QDROs should draft the order, as there are many potential mistakes and it must be approved by the plan administrator to take effect. The approval process can take weeks to months, but it should be done before the divorce is final to avoid any surprises. Heaven forbid the parties come to an agreement only to find out later that the plan does not allow for what the parties have agreed to.
The methods used to value and divide a future stream of income can be complicated based on the individual circumstances of the parties and can have a big impact on the ultimate settlement agreement. Since this can be a significant portion of a person’s retirement plan, it should be examined closely so that both parties understand the implications for their long term financial stability. It is precisely in these situations where a Certified Divorce Financial Analyst® (CDFA®) can assist—not to help one party get a better deal than the other, but so that both parties can better understand and come to an agreement that is representative of the benefits accrued during the marriage.
Sarah Keys holds the CDFA® designation. This specialized, professional designation focuses on pre-divorce financial planning. A CDFA® helps guide a divorcing couple and/or their legal representation through financial issues that will affect their lives, including property valuation and division, retirement assets and pensions, spousal and child support, tax considerations, and expert witness testimony. This certification draws both on Sarah’s professional background as a family law attorney and her knowledge of financial planning and investment strategies.
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