Breaking Up (the Pension) Is Hard to Do
In a divorce, splitting up the pension is trickier than dividing the house.
Divorcing couples and their advisers “who aren’t hip to divorce splitting of retirement plan assets often do it improperly,” said Howard Phillips, a Delray Beach, Florida, actuary and author of “Dividing Retirement Plan Assets in a Divorce.” He knows, because he values pensions for couples negotiating their divorce settlements and then drafts the order that will be entered into the court.
Dividing a house is easy. Two realtors pouring over sales of comparable nearby properties can readily agree on a value – once the house is sold, the parties pay the realtor and split the proceeds. But a pension plan’s value greatly depends on how and when it’s counted and the method used to allocate that value between the spouses.
Phillips explained the basics of how defined benefit plans and defined contribution plans – 401(k)s, 403(b)s, and IRAs – may be handled in a divorce during a recent podcast for the Retirement Income Industry Association. The following methods for splitting a pension 50/50 have strikingly different outcomes for the participant in the pension plan and for his or her former spouse:
Defined contribution plans:
- Tracing assets: If one spouse comes to the marriage with $50,000 in a 10-year-old 401(k) account, only contributions made during the marriage – and investment returns on the new contributions – are divided. If the plan now has $150,000, the amount that’s divided up can vary widely – or it can be zero if no new contributions were made during the marriage. The remaining balance goes to the spouse who started the 401(k) account.
- Subtraction: The $50,000 initial balance is subtracted from the $150,000 account, and only the $100,000 is split 50/50. This generally favors the spouse who had little – or no – savings prior to marrying and will receive some of the investment income on the initial amount.
- Coverture: The entire $150,000 retirement account is put into a shared pot. The formula for determining how much of the pot is split equals the number of years of marriage – say 10 – divided by the number of years the person participated in the plan – say 20 years. That’s one-half of $150,000. So the spouses share $75,000; the spouse who brought the 401(k) to the marriage retains the other half.
Defined benefit plans:
- Dividing benefit payments: If the participating spouse earned the entire pension while married, the stream of future pension payments is divided evenly – but only after the participant retires and claims a benefit. For example, if the annual pension is expected to be $30,000, each party will receive $15,000. But if some of the benefits were earned prior to the marriage, the payment stream may be prorated to ensure fairness to the plan participant.
- Carve-out: The non-participating spouse may not want future benefit checks to hinge on things he or she can’t control. For example, the pension plan participant might quit working or die suddenly, leaving a smaller pension than if the former spouse had worked longer. So, the non-participating spouse can hire an actuary to estimate the future annual pension payments he or she is entitled to in the future. The court may then order the plan sponsor to carve out a separate defined benefit plan to pay the non-participant her agreed benefit.
- Value and offset: Some employers allow participants to cash in their pension benefit for a lump sum, which is easily split. If not, an actuary can estimate the value today of the total future pension payments, say $200,000. The non-participating spouse then receives other assets – a home, jewelry, a car – also valued at $200,000. The risk here is to the spouse who retains the pension: if he dies young, he never enjoys any of the shared wealth accumulated during the marriage.
Even after the final divorce decree is signed and sealed, a thoughtful division of pension assets remains important. “A very ambiguous” property settlement agreement can, Phillips said, “cause the parties to argue a lot.”