Pension benefits (sometimes calls Defined Benefits Plans) are largely going the way of the dinosaur. But for those who have them, it's important to accurately assess their value - both monetarily and in the context of a settlement agreement. This article will outline what a pension benefit is, how it's divided, and how you can assess its value.
What Is a Pension?
A pension is a type of Employer Sponsored Defined Benefit Plan: Employer Sponsored because it is a benefit offered by an employer to an employee, and Defined Benefit because the plan promises a specific benefit at a specific point in the future. The type of pension most of us are familiar with is the pension that makes a monthly payment to the pensioner starting at retirement and continuing until his or her death. If the pensioner is married, a smaller payment may continue for his or her surviving spouse until the death of the surviving spouse.
The key element of a pension is that payments, must be made for life - regardless of how long that life might be.
How Is a Pension Divided in Divorce?
Pension plans (or pension benefits) are divided using a legal instrument called a Qualified Domestic Relations Order (QDRO). This document can be drafted as Shared Interest or Separate Interest. In a Shared Interest QDRO, the non-employee may begin receiving benefits when (and only when) the employee begins to take his or her own benefits. This arrangement works well for pensions already in pay status - that is, when benefits are actively being taken at the time of divorce.
A Separate Interest QDRO allows the non-employee to begin receiving benefits when the employee attains retirement age. This arrangement works well for pensions not yet in pay status. If you are the younger spouse and you need income to support yourself, it's better to wait for your ex-spouse to age (inevitable) than to retire (not always inevitable).
What's a Pension Worth?
That's the million-dollar question - literally! Most of us struggle to conceptualize how valuable a pension is because it's a series of future payments. We aren't set up to visualize that effectively. So, let's look at an illustration.
Say we have a 401(k) worth $1,000,000 and a pension benefit that pays $4,251.60 each month for life. Which would you choose? Which is worth more?
The answer might surprise you.
If we assume that these monthly payments will last 30 years (typical retirement timeframe) and that inflation will be 3% annually, those payments are worth $1,000,000 today.[1] A financial professional like a Certified Divorce Financial Analyst™ (CDFA®) can perform these types of calculations to help you see the value of a pension more clearly.
The computational method used above is often referred to as the present value of future cash flows. While it's valid, it isn't perfect. Another way to value a pension benefit is to hire an actuary to complete a formal valuation. An actuary will complete a more complex set of computations with a more sophisticated set of assumptions. Such a valuation can be costly to perform and is often not worth the money unless there is irreconcilable disagreement about the value of the pension benefit.
A third method (and by far the cheapest) is to ask the plan sponsor to make an estimate of the lump sum the pension would pay out at the participant's retirement. Not every plan offers a lump sum payout option, so this may not be a viable method for your case. But it's worth asking about.
Lastly, if you choose to simply divide the pension income 50/50 between you and your soon-to-be-ex-spouse, the exercise of assigning a dollar value to the pension is moot.
Do I Want the Pension?
Maybe. By law, half of a party's retirement benefits earned during the marriage are owned by his or her spouse and are thus subject to division in divorce.[2] But if there are other assets available, you may or may not want to have part of the pension benefit awarded to you. When deciding if trying to get part of that pension is worth it, ask yourself:
- Am I willing (or able) to wait to receive benefits?[3]
- Do I desire (or need) guaranteed income for my lifetime?
- Am I willing (or able) to follow up on the Qualified Domestic Relations Order needed to receive the benefits awarded to me?[4]
- Would I be better off accepting an investing account or cash that might be invested? Is it reasonable to believe that I might ultimately enjoy a more secure retirement if I invest those dollars wisely?
- Do I desire flexibility in managing the assets awarded to me?
Just because a pension benefit is available doesn't mean you must allocate half of it to your side of the asset division spreadsheet. A CDFA® can help you sort through the questions above using sophisticated financial planning tools so that you and your attorney can make a well-informed choice when settling your case.
Need guidance?
[1] When assessing the value of a pension benefit, you'll need to make some educated assumptions. That's why having a professional like a Certified Divorce Financial Analyst™ (CDFA®) on your divorce team may be a wise investment.
[2] One exception is benefits accrued before the marriage. Those are separate property and not subject to division. In a case where a pension is a mix of separate and community property, an actuarial valuation may be needed. Rely on the advice of your attorney.
[3] Especially important if your spouse is many years from attaining retirement age.
[4] Qualified Domestic Relations Orders can take months to process and it may take several phone calls with the plan to get your benefits sorted out.