Dividing defined benefit pensions in divorce

The way in which you value a pension for divorce depends on the type of retirement plan. There are two basic types of retirement plans: 1) “defined contribution” retirement plans, like 401k’s, and b) “defined benefit” retirement plans, which are often referred to simply as “pensions”. These defined benefit pensions are common among public employees, whether federal, state, or city employees or public school teachers. They are less common than they used to be among private employers.

Dividing defined contribution plans, like 401k’s, is simple conceptually and mathematically. (See below, “Dividing defined contribution retirement plans in divorce”.) Dividing defined benefit retirement plans between divorcing spouses is much more complicated.

First, one must choose between two different options for sharing the pension:

  1. The couple can divide the future stream of post-retirement monthly payments. This is sometimes called the “deferred distribution method.”
  2. The couple can divide the “present value” of the pension at the time of divorce, sometimes called the “immediate offset method.” This involves transferring a lump sum value to the non-participant spouse at the time of divorce, and then the participant keeps all future pension benefit payments for him- or herself.

The monthly benefit of these defined benefit pension plans is determined by a specific formula or calculator provided by the employer. For public employees, these formulas often include the participant’s age at retirement, the number of years of participation in the pension plan, and an average of the highest years of salary. Unlike a 401k or 403b, the value of a pension is completely unrelated to the amount of money that has been withheld from paychecks or pooled in an account.  Here are links to information about the specific pension formulas at the 100 largest US pension funds and over 5000 additional pension providers.

Dividing monthly pension benefits as they are distributed during retirement

The future monthly benefits of a defined benefit pension plan can be shared in the future, during retirement, using a DRO (“Domestic Relations Order”). This document–typically written by a divorce lawyer or accountant and signed by a judge as part of the divorce order–gives specific instructions to the pension administrator as to how future pension payments from the pension should be divided between the pension participant and the ex-spouse.

There are two common methods for determining future pension benefits with a DRO. Different states have different rules about which method can be applied.

1) The “accrued” (also called “bright line” or “direct tracing”) method considers only the value of benefits accrued specifically during the marital years. If these marital years are during the early years of pension plan participation, this often results in less of the eventual pension being shared with the alternate payee, the ex-spouse. This is because many pension plans use formulas that devalue the early years of plan participation and disproportionately value the final years of plan participation. Many states do not allow this method of dividing a pension.

2) The “relative time” (also called “projected” or “coverture” or “fractional rule allocation”) method is required by law in most states, and it is recommended by the American Law Institute in Principles of the Law of Family Dissolution: Analysis and Recommendations (§ 4.08). This method values each year of pension plan participation equally, based on the idea that the marital years of pension plan participation lay a foundation of years of service that allow a participant to reach the high years of service, eventually, that result in high pension benefits (“marital foundation theory”). Thus, if a couple is married for 15 years, and the spouse with the pension ends up participating for 30 years, the “marital portion” (or “coverture factor”) of the total benefit is 15/30, which is equal to 50%. This 50% of the eventual benefits thus “belong” to the marriage. The non-pension-participant spouse would get one half of this marital portion of the pension, which would be 25% of each monthly pension benefit payment at retirement.

Dividing a defined benefit pension by calculating a present value

In some situations a couple may not want to share future, monthly pension benefits but would rather determine the value of a pension in the present, at the moment of divorce, and use this value to offset other assets being kept by a spouse. The present value of a pension can be calculated using the present value pension calculator on this site for $35 or by paying an accountant or actuary between $175 and $300.

Once you have determined a present value for the pension, this value can be treated just like the value of any marital asset that is divided at the time of divorce. This allows the pension-participant spouse to keep all the future monthly benefits from the pension, if they want, and allows the non-participant spouse to keep other marital assets with equivalent value.

This “buy out” method can be particularly helpful if one spouse wants to keep the marital house and the other spouse wants to keep the pension. If a couple has $250,000 equity in their house, and one spouse has a pension with a present value of  $250,000, one spouse can keep the house and the other spouse can keep the entire pension without any cash changing hands.

Dividing defined contribution retirement plans in divorce

“Defined contribution retirement plans” include 401k’s, 403b’s, and IRA’s. In terms of value, these are much like savings accounts. The value of the plan at any given time is simply the account balance of the plan at that time, so there is no need to calculate a present value for them.

In divorce, the value of the account is typically divided into a pre-marital portion–the money accumulated in the retirement account before marriage–and a marital portion, which is the amount of money accumulated in the account during marriage. This marital portion of the account is then treated as marital property, and is divided, along with other assets, between spouses at the time of divorce. A special document, called a QDRO (for private employer retirement plans) or a DRO (for public employee retirement plans), tells the pension administrator how to divide up the 401k or 403b account. These funds can be moved directly from the retirement account of one spouse to a retirement account of the other spouse, so that the money does not become taxable–it is always in a retirement account. No QDRO is required for IRA’s that are divided, as the spouses themselves administer these accounts and can transfer money to the other spouse’s IRA.