When the spouses have sufficient assets, the offset method – trading the pension in exchange for, say, a mutual fund – may be more advantageous than a QDRO and a share of the participant’s pension; however, the participant cannot force his or her spouse to accept a “cash out” of his or her share of the pension.
A pension is a marital asset acquired during the economic partnership of a marriage. In the division of marital property, the plan participant – the participant – does not have a greater right to the asset than his or her spouse. Forcing a spouse out of a pension distribution may deprive him or her fair share of the pension’s growth. Sometimes the participant becomes very protective of his or her pension, arguing that he or she worked for it. No so. The pension belongs to both spouses.
A cash out or QDRO is often the first big decision the divorcing spouses must make after the pension appraisers determine the present value of the pension, but the decision must be made without coercion. The non-employee spouse should remember that the participant’s pension might be more valuable than the marital home. Present value, which is also called the time value of money, is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows.
The present value — or cash out value — makes it easy to use the pension during settlement negotiations. This routine awards the non-employee spouse (alternate payee) a lump sum settlement – or a marital asset of equal value – at the time of the divorce in return for the employee’s keeping the pension.
Since a pension is a marital asset, both spouses must know what the pension is worth, particularly the non-employee spouse who must know the present value of the pension to make a trade-off work to his or her advantage. The present value of a defined benefit pension cannot be ascertained by the projected monthly benefit. Annual benefit statements are misleading because they are often based on the assumption that the participant works until retirement, which can result in a large overstatement in the present value. Annual benefit statements do not replace the need for a pension appraisal, which some courts routinely require.
Most pensions are paid monthly over the worker’s lifetime and start at retirement age. The amount a participant is to receive generally depends on how many years he or she worked, how much he or she earned, how old he or she is when upon retirement, and how long a person his or her age is expected to live after retirement. For example, a pension of $1500 a month payable to a retiree who is now 65 years old might be considered to have a lump sum value of $130,000.
Trading away a pension plan requires careful thought of both short-term and long-term considerations. For example, even if a pension is divided 50/50, the division may produce what are termed “disparate results” because the ages of the payee, the worker spouse, and the alternate payee, the nonworker spouse, are different (and often the latter is significant younger than the former). Trading a house for a share of a pension often produces such unfairly unequal results.
Even though the participant collects his or her benefit as a monthly pension, the non-employee spouse needs to know the present value of the pension today to make an informed and intelligent decision about whether he or she might want to trade off his or her share of the pension for other marital property of the same value.
When both spouses have pensions, each has latitude to use them for the horse-trading that happens in divorce negotiations. Just as Susan has a claim against Sam’s pension at ABC Co., so Sam has a claim against her pension at XYZ Inc. Rather than dividing Sam’s ABC pension and Susan’s XYZ pension, he and she may decide to tradeoff another asset, for example, a portion of Sam’s share of the marital home. Susan may be tempted to trade away her share of her Sam’s pension for the marital home without appreciating that a house is a barren asset that costs money just to occupy.
Care must be taken in making sure that the buyout accurately reflects the value of what is traded off. In her book Survival Manual to Divorce, Carol Ann Wilson describes how a wife took a $12,000 baby grand piano, but passed up her chance for half of her husband’s $2,300 per month defined benefit pension, which had a present value of $250,000. “[S]he could have exchanged her half of Frank’s pension upfront for $125,000 worth of another asset…or she could have waited until Frank retires to obtain her share of the marital portion of his benefit. What seemed to have been a few thousand dollars on the surface proved to be a costly mistake in the end,” Wilson writes.
Considerations other than the value of the pension may influence the decision. More than twice as many men as woman have retirement benefits, and the benefits for men are generally much larger than those for women. Women, therefore, find themselves in a position to trade spousal pension rights for other assets. For example, the middle-aged homemaker may be very concerned that she faces the prospect of retirement without a pension and opt for a QDRO, which gives her a share of her former husband’s pension. A childless professional couple may take the pension division off the table by agreeing that each keeps his or her pensions.
Basically, however, the decision to go for a buyout or a QDRO has pluses and minuses for both the pension owner and the nonworking spouse. For the participant, a buyout means he or she enjoys all the benefits earned because of future increases in salary and continued years of service. For the non-employee spouse, a buyout provides cash in hand now. On the other hand, for the pension owner, deferred distribution via a QDRO avoids argument over the discussion and analysis involved in the pension appraisal. For the nonowning spouse, deferred distribution via a QDRO means the nonowning spouse may share in future salary and years of service earned by his or her former spouse.