Valuation of Pensions in Divorce
Key Points
  • When a pension is valued there must be a valuation date established regardless of whether you have a defined benefit or defined contribution plan.
  • A defined contribution plans valuation is easy. It is the balance of the money that is in the account as of established date.
  • Defined benefit plans have to be appraised to determine a present value.
  • The present value of a defined benefit plan if not calculated correctly, can be harmful to the alternate payee spouse.

At some point, a valuation date must be established as part of the divorce process for both a defined benefit and a defined contribution pension plans.

Defined contribution plans, such as 401(k)s, are easier to value than defined benefit plans. Defined benefit plans are more difficult to divide because the payout is based on a plan formula, not an individual account, and settlements may have to consider post decree increases, which is a frequent area of contention.

In a divorce, the value of a defined contribution plan is easy to calculate: it is simply the balance of the account. However, the valuation date - that is the date when the plan is valued for divorce division - is very important because, unlike the defined benefit plan (the old-fashioned company pension), the value of a defined contribution plan can and does fluctuate dramatically after a couple separates but before they divorce. Millions of Americans who imagined that a sky-high Dow-Jones average insured them of easy golden years learned this the hard way when the stock market crash wiped out their retirement savings as part of the Great Recession.

In a defined contribution plan, monthly or quarterly statements show the individual's account available to be divided. Defined contribution plans cash value today: the dollar value of the account. A portion of the defined contribution plan can be transferred to the former spouse without any tax consequences by establishing a trustee-to-trustee transfer of the funds to an Individual Retirement Account (IRA). Or the account may be divided. Some companies allow for the plan to be divided so that the former spouse also now has an account.

By comparison, determining the value of a defined benefit pension requires that it be appraised to determine its present value. This requires the services of an actuary specializing in such calculations. Normally, one of three methods is used to divide defined benefit pension plans: 1) present value or cash out method, "which awards the non-employee spouse a lump sum settlement - or a marital asset of equal value - at the time of the divorce in return for the employee's keeping the pension"; 2) "deferred division' or future share...where no present value is determined [and} [e]ach spouse is awarded a share of the benefits if and when they are paid" and 3) "reserved jurisdiction,' whereby the court retains the authority to order distribution from the pension plan at some point in the future, [normally] ... a last resort, as it leaves both spouses in limbo with regard to planning for their future."

As it applies to a defined benefit pension, the calculation of worth often means the present value, or the time value of money. Present value is the current worth of income to be received in the future. Present value describes the amount of money which would have to be set aside of that sufficient funds are available to pay out the pension amount throughout the employee's years of retirement.

As it applies to the middle aged woman facing divorce, the failure to appreciate the enormous present value of a husband's pension can lead to disastrous decisions in divorce negotiations. This can become very important for a woman facing the prospect to reentering the job market indifferent to her stale work skills.

Suggested Reading
Pension Issues in Divorce Pension Issues in Divorce
When couples get divorced they must decide how to divide their property. Retirement benefits (pensions) often form a substantial part of the parties' total marital estate and many times are the largest single marital asset afforded the couple. Similar to other assets, pensions are typically divisible in cases of divorce to the extent that they are acquired during the period of marriage.

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MANY MODELS -- Pension and retirement plans come in a bewildering array, with many diverse provisions; however, the two basic models are: the defined benefit or defined contribution. The defined benefit plan is generally a retirement annuity, wherein the employee contributes nothing and the employer sets aside benefits for all employees in a pool; the defined contribution plan is an individual or separate account in the employee-spouse's name, whereby he or she contributes pretax dollars to his or her account that are matched to a certain amount by the employer's contribution.

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