Pension Division in Divorce
Jenni (specifics details have been changed) came to our office for post-divorce financial planning. Jenni is 60, a former stay-at-home Mom and current yoga instructor with two grown children. She never had a professional career and spent much of her adult life with a series of low-paying part-time jobs. She is thinking about retiring now and wanted to know whether she would be able to make it through retirement without running out of assets.
Jenni traded her interests in her husband’s 401(k) in exchange for the marital home, an IRA and half of a brokerage account . The lawyers agreed that the 401(k) should be discounted by 25% to take into account the fact that a 401(k) holds pretax assets.
Adjustments to the Value of a 401k
That sounds reasonable on the surface. But as a professional financial planner, I believe that it was a mistake for Jenni to agree to a 25% discount adjustment to the 401(k). After analyzing her finances, it became clear that Jenni would likely always be in a lower-than-25% federal tax bracket after retirement. Had she met a Divorce Financial Planner sooner, he or she would have likely advised against agreeing to a 25% discount to the value of the 401(k).
Jenni and Ron, her ex-husband, also agreed that she would get half of her marital interest in a defined-benefit pension from his job as a pediatrician with a large hospital. At the time that pension division was agreed to, Ron thought that there was no value to the pension, and it was probably “not worth much anyway.” Neither lawyer disagreed.
[A Pension does] not come with a dollar balance on a statement
This underscores the importance of seeking the advice of the right divorce professional to analyze financial issues! Working in a team with mediators and divorce lawyers, divorce financial planners usually pay for themselves .
After a little research I found that Jenni would end up receiving a little over $37,000 a year from the pension division at Ron’s retirement, assuming he is still alive then. This is far from an insignificant sum for a retiree with a projected lifestyle requirement of less than $5,000 a month!
There are also restrictions with dividing Ron’s defined-benefit pension: the ex-spouse or alternate payee (Jenni in this case) can get his or her share only when the employee takes retirement. Furthermore, the payments stop when the employee passes away. (Each defined-benefit pension has its own rules . Each defined benefit pension division should be evaluated individually ).
The Value of Pension Division Analysis
A defined-benefit pension such as this one does not have a straightforward value in the same way as a 401(k). It does not come with a dollar balance on a statement. A pension is a promise by the employer to pay the employee a certain amount of money in retirement based on a specific formula . In order to get a value and for it to be fairly considered in the overall asset division, it needs to be valued by a professional.
In her case, Jenni’s share of the pension division was 50% of the marital portion of the defined-benefit pension. Was it the best outcome for Jenni? It is hard to re-evaluate a case after the fact. However, had she and Ron known the value of the pension, they might have decided for a different pension division that may have better served their respective interests. Jenni may have decided that she wanted more of the 401(k), and Ron may have decided that he wanted more of the pension. Or possibly Jenni may have considered taking a lump-sum buyout of her claim to Ron’s pension . In any case, they would have been able to make decisions with their eyes open, instead of taking the path of least resistance.
The news that her share in Ron’s defined benefit pension had value was serendipity for Jenni. It turned out that the addition of the pension payments in her retirement profile substantially increased her chances to make it through retirement without running out of assets. But it is possible that an earlier understanding of the pension division and other financial issues could have resulted in an even more favorable outcome for Jenni .
A previous version of this article was published at Kiplinger.