How courts treat pensions in divorce, Part 2Posted April 2010. Filed under Property & Financial Matters
Part 1 covered the basics of pension division in divorce. Now let’s talk about the orders courts write to direct the divsion of the marital portion of a pension.
The actual time at which the pension benefit is divided and how that benefit is valued depend on what kind of pension you have.
Most private and public pensions are one of two types— defined benefit or defined contribution. The two kinds of plans are treated differently.
A defined benefit plan generally works like this: Add your highest three years of earnings, then average them. Your defined benefit plan specifies that your pension benefit will be a set percentage of that average for each year you worked. Here’s an example:
$100,000 average earnings x 1 percent per year x 40 years = $40,000 annual benefit
Here’s the tricky part. That calculation often changes from year to year. Maybe your highest three years average out to $100,000 today, when you’re divorcing. But by the time you actually retire, the three-highest-years average might be $120,000.
That means you really don’t know the value of your pension –the actual dollar benefit— until you retire. How does the court handle this today, which may be many years before you retire?
It writes an order for the pension benefits to be divided starting on the day you retire and begin to take your pension. The actual benefits are valued at that time.
In other words, the marital portion is not valued at the time of divorce but at the time of retirement. Although the order may be written years before, the pension isn’t divided until that retirement date.
A defined contribution plan, such as a 401(k), has a value that can be set at the time of divorce. In this type of plan, you make a pre-tax contribution each year and your employer usually matches some part of it.
Generally, you determine how the money in your retirement account is invested. Its value at any moment equals the total contributions plus earnings or minus losses.
In a defined contribution plan, the actual value of your pension is known at any time. So when your marriage ends, the court determines the marital portion and writes an order assigning your spouse the proper share of the account. Usually, that amount is paid out when the court’s order is given to the plan.
The defined benefit plans with payout at the time of retirement and the defined contribution plans with an immediate payout cover most situations. But there are hybrid plans and other variations that can be quite complicated.
In all cases, don’t assume the court will make the proper pension division automatically. Mistakes can be costly and expensive to correct. Make sure your attorney understands pension law, how to divide pensions, and how to structure payouts.