Divorcing couples and their advisers who aren’t hip to
divorce splitting of retirement plan assets often do it improperly. 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.
Howard Phillips, actuary and author of “Dividing Retirement Plan Assets in a
Divorce” 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.
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.
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.
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here to access the full article on Center for Retirement Research.