Welcome to FreeDivorce.com.
Christina: This is Christina.
Ed: This is Ed. Today, are going to talk the division of retirement assets. Dividing retirement assets is complicated. We can’t cover the basic information in just one video. We are going to need four videos. This first video, is an introduction to the topic of dividing retirement assets.
Christina: Ed, are there different categories of retirement assets?
Ed: Yes. Retirement assets can be grouped into two main categories: 1) Defined contribution; and 2) Defined benefit.
Christina: What is a defined contribution retirement account?
Ed: A defined contribution account is an account that contains an amount of money or stock that belongs to you or your spouse. Examples would be a 401(k) account or a 403(b) account. Your “benefit” from this type of retirement account depends or is “defined” by the amount of contributions made to the account. The contributions may be made by you or by your employer or some combination of the two.
Christina: What is a defined benefit retirement asset?
Ed: A defined benefit retirement asset is typically a pension. When you have a pension, there is not a particular account that contains money that belongs just to you. Instead, there is a giant pool of money that is used to fund monthly pension payments to a large group of people. The amount of the pension “benefit” you receive from this type of retirement asset is “defined” by a formula.
Christina: Can you explain the kinds of formulas that are generally apply to pensions?
Ed: Typically, the formula that will define or determine your monthly pension benefit will include the number of years of service credits you have earned through your employment, your salary, and your age. For example, the amount of your pension may be calculated taking into consideration your years of employment or “service credits”, whereby you earn 2% of your final salary for each year you worked for your employer. Under this formula, if you worked 30 years for your employer before retiring, you will receive a monthly pension equal to 60% of your final salary. Some pension plans look at your highest annual salary before applying the service credit percentage. Some pension plans will look at the average of your three highest earning years.
Christina: How does a person’s age at the time they retire factor into the pension formula?
Ed: Almost all pension formulas will also take into consideration your age at the time you decide to retire. Pension plans require you to reach a certain minimum age, which is called, “earliest retirement age”, before you become eligible to start retirement benefits. For many retirement plans, the minimum age is 55. For other pension plans the minimum retirement age may be 65, 62, 50 or even as early as 40. Usually, the older you are, and the longer you delay retirement, the more your monthly pension payment will be. If you retire at age 55, your pension may be $2,500 per month. But, if you wait to age 60 to retire, your pension may be $3,500 per month because the pension plan will pay you for a shorter period of time. There are lots of different pension plans and lots of different formulas that are used to define the amount of your pension benefit.
Christina: Are retirement assets community property that get divided when a couple divorces?
Ed: Yes. That portion of your retirement assets that was earned during the marriage is community property and is typically equally divided upon your divorce. The portion of your retirement assets that was earned before marriage is your separate property. The portion of your retirement assets that is earned after the date you and your spouse separated is also your separate property.
Christina: How do you divide a defined contribution retirement account?
Ed: As I mentioned earlier, a defined contribution account is a retirement asset, typically an account held in your name that contains assets that belong to you. Let’s assume you have a 401(k) account with $50,000 in it. Let’s assume some of the money was earned before marriage, some was earned during the marriage, and some was earned after you and your spouse separated. You want to equally divide the community property portion of your account with your spouse as part of the property settlement. How do you do it? You can’t just take money out of your retirement account and give it to your spouse.
Christina: Why can’t you just take your spouse’s share out of the account and pay it to your spouse?
Ed: First, you can’t withdraw money from your account so long as you are employed by that employer, and even if you could, you would not want to make the withdrawal because you would then have to pay income taxes on the amount withdrawn, plus an early withdrawal penalty if you are under age 59 and a half.
Christina: Well then, how do you get your spouse’s share of the funds out of the account?
Ed: What you should do is get a Qualified Domestic Relations Order, commonly called a “QDRO”. A QDRO is a special type of court order, authorized by federal law, that permits the custodian of your 401(k) account to take a portion of your 401(k) account assets and pay it over to your spouse as part of a divorce settlement. If you use a QDRO, there are no immediate income tax consequences to you or your spouse and no early withdrawal penalty.
A QDRO is a court order that contains certain provisions required by federal law and also includes an instruction to the custodian of your 401(k) account telling the custodian how much of your account is to be paid over to your spouse. The QDRO may tell the custodian to pay a certain amount to your spouse, such as $20,000. A QDRO may tell the custodian to pay a certain percentage to your spouse, such as 50%. In the alternative, the QDRO instruction to the 401(k) custodian may say something like, the date of marriage was January 1, 2005, and the date of separation was June 30, 2018, pay your ex-spouse one half of all contributions made to your account between those two dates, adjusted for any accruals or losses on those contributions. If you just give the plan administrator the date of marriage and the date of separation, many plan administrators can use their records and figure out what part of the 401(k) account is community property.
Christina: We now know how to divide a defined contribution account, such as a 401(k) account, by splitting the funds in the account that were earned during the marriage by using a QDRO. How do you divide a pension?
Ed: There are different ways you can deal with a pension. We have to start by talking about what part of the pension is community property. Assume you have worked for your employer for 30 years and your employer provides you with a pension as part of your compensation package. Also assume you have been married for the past 20 years. You are now getting a divorce. The portion of your pension benefit that was earned during the marriage is community property and would typically be divided with your spouse. The portion of the pension that was earned before marriage is your separate property and the portion earned after the date of separation is also your separate property.
Christina: How do you divide the community property portion of the pension?
Ed: One option is to have the community property interest in your pension appraised and then buy out your spouse. You can hire an actuary to calculate the value of the community property interest in your pension. An actuarial appraisal should not be very expensive, around $300 to $500. You can Google “pension valuation” and get some quotes for the appraisal.
Christina: Is a buyout a good approach?
Ed: A pension buyout is usually not a good idea for a number of reasons. First, you have to understand that when actuaries value pensions, they do not discount the pension for income tax consequences. In other words, they treat the pension payments as if the payments will be tax free, which they are not. Second, there is the issue as to where the money will come from to pay your spouse the buyout amount. Pensions can be very valuable and the buyout amount can be large. Third, you may be young and your pension may not be payable for another 20 or 30 years, assuming you live that long. Do you want to pay a lot of money today for pension payments you won’t see for many years? Fourth, if you will be paying your ex-spouse child support or spousal support for a period of years, including after you retire, then you do not want to buy out your spouse’s interest in your pension and later have the court use that pension income for purposes of calculating how much support you owe.
Christina: If a buyout is typically not a good idea, how else can you divide the community property interest in a pension”
Ed: The better approach is to split the pension benefits by using a QDRO. A pension QDRO is generally going to split the pension by means of a time rule formula. For example, assume you worked 10 years before marriage, 20 years during the marriage, and another 5 years after you separated from your spouse. You worked a total of 35 years to earn the pension. You were married for 20 of those years. That means that 20/35ths of your pension was earned during the marriage or about 57%. If your pension payments when you retire are $1,000 per month, 57% would be community property or about $570 per month. Your spouse would be entitled to about half the community amount or about $285 per month. You would receive the rest. The actual amount of the pension payments each party receives will also depend on each party’s age and other factors.
Christina: What do pension QDROs typically say?
Ed: A pension QDRO will typically recite the date of marriage and the date of separation and then instruct the pension plan administrator to allocate the pension benefits using a fraction where the numerator is the number of years of service credits earned during the marriage and the denominator is the total number of years of service credits earned during the entire period of your employment. Said fraction will determine the community property share of the pension benefit. The pension administrator will then write two pension checks each month, one to you for your share of the pension and one to your ex-spouse for his or her share of the pension.
There are other ways a pension QDRO can divide the community property interest in a pension and there are other issues that should be addressed in a pension QDRO, including what happens if one spouse dies before the pension payments begin. If you hire a qualified professional to draft your QDRO, the professional should make sure to draft the QDRO so these other issues are properly addressed.
We are going to discuss QDROs in more detail in the next video.