01 Mar Understanding Pension Plans in Your Divorce
If there wasn’t enough to sort through, employer pension plans can be a particularly confusing aspect of dividing your assets in a divorce. From decoding what pension plans truly are to understanding whether you need a valuation for one that you or your ex-spouse has, takes the expertise of a professional. In this post, we help answer your top questions about how to handle a pension plan in your divorce.
What is a pension plan?
A pension plan is a type of employee retirement benefit plan. More common nowadays in public sector jobs, a pension provides eligible employees with a promise to pay future income streams (monthly) upon retirement. A pension plan can be provided to employees as the sole employer retirement plan or in addition to other saving plans such as a 401k, 457 plan, etc where the employee can elect to contribute and to what amount. A pension is funded by employer contributions into a pool of money that is set aside to fund future payments to retired employees. Employees must meet eligibility requirements to qualify for future benefits which is determined by a formula based on the employee’s years of service and their compensation over time.
Pension benefits are paid out at retirement and the money is available to employees after reaching a certain age such as 60, 62 or 65. Payments received are taxable unless a lump sum of the benefits are rolled into an IRA. Retirees will receive monthly payments for the rest of their life. Therefore, the value of what a retiree will receive over their lifetime is unknown, not to mention the value of what it is worth currently and in a divorce proceeding.
How are pensions paid out?
Pensions can be paid out in one of two ways. Retirees can choose either monthly payments over a lifetime or a lump sum at retirement. For monthly payments, amounts are modified based on whose lifetime the payments cover. Those options include retiree only, retiree and spouse, and other predefined payout options.
Lump sums can be rolled directly into an IRA account where funds can be accessed based on IRA rules. This is common for tax, investment budgeting reasons. However, unlike more traditional retirement options, like 401Ks and IRAs, pension benefits are usually not accessible prior to retirement
What is a Valuation and when is one necessary?
Retirement accounts are often a complex part of asset division, and pensions fall into that category. Unlike a 401k account that has a stated current value, a pension that provides funds over a lifetime does not have an exact value as of today. This is because of the way pensions are paid out. For example, someone may die and only receive benefits for five years while another retiree may live longer and receive more payments. Therefore, it is difficult to determine the value of a pension when calculated for the purposes of divorce. It is essential to have a professional help with a pension valuation, which determines the separate value and marital value of the pension for proper division.
Like other assets, if you or your spouse earned future pension benefits during your marriage, it is usually considered marital property. Benefits accrued before your marriage or after your divorce would be separate property. In order to complete a valuation and understand the current pension value pertaining to a divorce, a valuation expert will take various factors into consideration to determine the value of your pension, including:
- Valuation date or the date in which the plan is valued for divorce division
- Average lifetime expectancy (states have different statutory guidelines)
- Date of the marriage
- Date of hire
- Date of employment termination (if applicable)
This information will help determine what percentage of the pension value is marital.
Valuations are extremely important if assets will be ‘offset’ in your division, which is fairly common. For instance, you may want to stay in the marital home and therefore your ex-spouse may receive more of another asset, like a pension, to offset the value of your home. A valuation helps you value, compare, and accurately divide assets.
If you are the non-employee spouse and expect to receive future benefits as an agreement in your divorce, it is crucial to work with a Certified Divorce Financial Analyst (CDFA) to understand and plan for other complexities regarding the timing of your pension payments. For example, you may not want to wait until your ex retires in order to withdraw funds from the pension. In another important scenario, you will want to make sure you can continue to receive pension payments in the event of your ex-spouse’s death, instead of those payments ceasing due to your ex spouse’s death (usually by executing a QDRO or DRO).
Lastly, if you or your ex-spouse already receives pension benefit payments, a valuation is typically not needed. Also, if a pension is going to be split 50/50 between spouses, a valuation may not be necessary.
Once valuation and division agreements are complete, you must file a qualified domestic relations order (QDRO) to receive the payment benefits from a pension.
In order to successfully divide a pension, work with a CDFA who can help you understand your pension valuation and division options as part of dividing your overall assets. At A.M. Financial, we can complete pension valuations for your divorce case. Pensions contain a critical part of your future earnings and can often be a very large percentage of a couple’s total assets. It’s critical not to underestimate a pension’s value. In some cases, they can be worth as much as or more than your home. As you fully understand your pension plans, you can divide them in ways that help you meet your future financial goals. Contact us to learn more.