Finance - Dividing a Defined Benefit Pension

Q: I have a defined benefit pension plan with my employer.   Does that mean that I get to keep the plan in the divorce?

A: Not necessarily.  Although it is not uncommon for spouses to keep their own pensions, it is also not uncommon for pension plans to be divided upon a divorce.   

Q: How does that work?

A: It typically  works one of two ways.   

• Actual division.  The pension can be divided, using a legal document known as a "Qualified Domestic Relations Order" (abbreviated "QDRO," and pronounced "Quadro").  The QDRO would specify that, for example, half the account is now to be in the spouse's name, and that half of any future payments are to be made into the spouse's account.

• Asset exchange.  A value is placed on the pension.  Say the pension is agreed to be worth $25,000.  Then the other spouse would take, say $25,000 of other assets in the property division to balance the employee's keeping the pension.  The key, here, is accurately estimating the value of the pension.

Q: Let's back up a second.  Is a 401(k) plan a defined benefit pension?

A: No.  A defined benefit pension is the kind where the company agrees to pay some amount, based on salary and starting at retirement, until the employee dies. 

The amount may or may not have an inflation adjustment.  Sometimes, the employee may opt to have smaller payments run until the both the employee and his (or her) spouse die.   

But the key to a defined benefit pension is that it is simply a promise to pay money upon retirement.  It is not an account that is currently invested in securities and other things that have a measurable account value.

So a 401(k) and an IRA and a SEP and most of the other alphabet soup plans are not defined benefit plans.  (They are called "defined contribution plans.")  If you receive a statement regularly that shows the value of your plan, then it is not a defined benefit plan.

A defined contribution plan is much easier to value -- you just look at the account statement.  But a defined benefit plan is very tricky to value accurately.

Q: So how do people go about valuing defined benefit plans?

A: The first step is to look at the plan and estimate what the monthly benefit payment will be.  That depends on the precise provisions of the plan and on what the employee's salary will be.  Often, appraisers assume that the salary will not increase from its present level.    

Then, you estimate when the employee will retire.   Often, appraisers assume that the employee will retire at the earliest possible retirement age.

Q: Are these assumptions always realistic?

A: The standard assumptions have the advantage of being "standard" -- that is, they avoid wrangling over those assumptions.  And the assumptions might reflect your situation.  But then again, they might not.   

Q: Given the assumptions about anticipated benefit and retirement date, what then?

A: Appraisers then use standard mathematical formulas to evaluate the future cash payments, just like those used to set a value for a government bond. 

There is one wrinkle here that is not present with a government bond, and that is this: the payments of a defined benefit pension typically stop if the employee dies.   

So the pension plan formulas also factor in the possibility that the recipient might die (and the payments stop) at any time.  To this end, life insurance actuarial tables play a part in the calculation as well.    

Q: Can Family Law Software help evaluate a defined benefit plan?

A: Yes.  Family Law Software has a pension evaluation module that can evaluate a defined benefit plan. 

Also, the pension evaluator explains in detail how the valuation is done, and it explains all the assumptions it is using.  By changing your entries, you can change the assumptions.  

Thus, you can get a value closer to the "true" value of the plan, with your own best estimates of salary at retirement and retirement date.

And, for negotiation purposes,  you can get a value that most accurately reflects your expectations about what will happen with the employee's salary and the employee's age at retirement.   

Because a pension division can be a huge part of the overall settlement, an investment in the Family Law Software Planner can pay off handsomely in increasing your ability to get a favorable settlement.

The Family Law Software Pension Evaluator will also help you work out which division scheme --  actual division or asset exchange -- is better for you.  It does this by giving you income and asset projections in each case.  You can see the impact of the different scenarios and decide which approach you prefer. 

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