By KAREN TELLEEN-LAWTON
(SENIOR WIRE) Divorce is difficult in so many ways. Arguably one of the most difficult in a maelstrom of thorny decisions is how to split up retirement assets.
Divorce law differs substantially among states. Even in community property states where half of community assets are awarded to each spouse, establishing the half isn’t as easy as it seems.
Pensions are a case in point.
The first step is understanding pensions. Companies today mostly offer defined contribution plans (DCP) where employees and sometimes employers contribute to retirement accounts. The DCP retirement account has a specific portfolio value at a given moment.
In contrast, pensions are defined benefit plans (DBP) where the value is not easily quantifiable with a single number.
A pension is a promise by the employer to pay out periodically, generally over a lifetime. Its ultimate value depends on many factors, including the participant’s age, how long they were employed at the company, their salary in the final few years, a possible cost of living factor, and ultimately how long they live.
The benefit also depends on whether it is to be paid out only until the employee’s death, or until the second death in a married couple.
When a couple is divorcing, they often submit their pension details to a pension expert who will use the plan’s payout details and make some assumptions about the employee’s age at future retirement and death, to provide various estimates of the pension’s future and present value.
The pension expert’s output might be a document stating dollar amounts for arcane values, such as the Accrued Vested Normal Retirement Benefit, the Vested Monthly Benefit’s Actuarial Value at Age 65, the Vested Monthly Benefit’s Actuarial Value at Present, the Tammen Nonliquidity/Non-pledgeability Reduced, the Community interest, and the Community Half-Interest of each pension.
Interpreting this document is both difficult and extremely important to achieving a result that is ultimately fair to both parties.
The bottom line on a pension valuation is the Community Half-interest. This shows the cash value of the pension to each spouse. If there are several pensions, these cash values can fairly be used to “trade” off one pension for another.
In a fairly typical case, one person wants the house and the other wants the pension.
It seems like a logical tradeoff, but both parties should be wary of using the cash value pension figures to trade off other assets. According to the Nuffield Foundation’s Guide to the Treatment of Pensions on Divorce, using the pension’s cash value for offsetting purposes is rarely appropriate. The option that is usually fairest is a figure based on the value of the pension holder’s “retained present or future benefits.”
As a simple example, say the monthly benefit on your spouse’s pension is $1,000 and the pension expert is valuing your community half-interest at $100,000. If your spouse offers you $100,000 for your half-share, however, will you be able to purchase the equivalent pension protection in the marketplace? To answer this, you need to know a little about annuities.
A private pension purchased in the marketplace is called an annuity. Annuities are purchased through insurance companies.
You can also check sample prices online at brokers such as immediateannuities.com. Here you can enter a purchase price of $100,000, along with your age and other details, to see what your monthly benefit would be.
Be careful to match the details of the existing pension as much as possible, such as any promised cost of living adjustment and the annuity’s start date.
Chances are, your $100,000 half-share won’t buy you half the monthly benefit, nor will it be as secure as a government pension. If the amount is lower, it is appropriate to argue for a large percentage of the pension.
The monthly benefit should be equalized, for that is the value that needs protecting.
If you’re separating from a spouse, you are already painfully aware that the next few years are going to be a grind, even if the divorce is amicable. Don’t be tempted to settle for an equal division when what you want is a fair division of retirement assets.
An equal division means each partner gets the same amount, regardless of need or whether, for instance, one spouse’s pension accumulation capacity has been significantly impacted by being a primary caregiver. A fair division means each party gets as close as possible to what they need and deserve. MSN
Karen Telleen-Lawton helps seniors help themselves by providing bias-free financial advice. She is a Certified Financial Planner professional, the Principal of Decisive Path Fee-Only Financial Advisory in Santa Barbara, California (www.DecisivePath.com). You can reach her with your questions or comments at [email protected].