Dividing a pension starts poorly when the parties — particularly the nonparticipant and his or her lawyer — fail to understand the type of plan to be divided. Generally, marital settlement agreements refer to the parties’ “retirement plans,” but do not specify whether they are defined benefit (DB plans) or defined contribution plans (DC plans), or both, or cash balance (CB plans), which are a combination of the two.
A QDRO should not be drafted from a marital settlement agreement that identifies retirement assets as “retirement plans” because the terms and conditions of DC plans, DB plans and CB plans are different. Often, however, in divorce negotiations, attorneys and parties refer simply to the “retirement plan,” but they don’t stipulate the type of plan the employee really has, and it is important to understand the differences among the plans.
The distinction between the types of plans is important because the parties need to know what is being divided — the right to receive monthly payments in the future, or a portion of an account with an identifiable balance that is fluctuating over time. Various issues, such as earnings and losses, surviving spouse benefits, and cost of living increases depends on the type of plan being divided.
Someone who participates in a DC plan normally receives periodic statements showing the exact balance in the account. Dividing a DC plans is simple, because the account value is easy to determine. It is often more complicated to divide a DB plan, because the value of the benefit requires actuarial calculations and assumptions regarding when the employee will retire or leave the company and what his salary will be at that time. By comparison, in DB plan, employees accumulate years of service and credits toward their retirement benefits. A traditional pension plan (the company pension) is the most common type of DB plan, in which employees know that if they work for ABC Corporation for thirty years, they will receive a monthly benefit of a certain dollar amount for the rest of their lives after retirement. Thus, the amount of benefit that they will receive is defined (unlike in a defined contribution plan). That is, an employee is guaranteed (after working long enough for the benefits to “vest”) a certain benefit based on the employee’s length of service and salary at the time of retirement. DC plans, such as the popular 401(k), depend on the performance of the investments in the account over time, so what is guaranteed, or “defined,” is the amount that the employer contributes periodically to the employee’s account.
In a defined contribution plan, the employee can make pre-tax contributions into an account maintained in his or her own name. The employer can also make contributions of a fixed percentage of the employee’s salary into the account. In a defined contribution plan, there is no guarantee as to how much money will be in the account when the employee retires.
Cash Balance Plans
There is another type of retirement plan that often causes confusion in divorce cases. Cash balance plans are a hybrid of defined contribution and defined benefit plans. They have become increasingly popular with employers in recent years. Cash balance plans are technically defined benefit plans, with many features similar to defined contribution plans. The value of a cash balance plan is usually expressed in statements as a “cash balance” – that is, they look a lot like defined contribution plans, because they show a precise dollar amount in an “account” for a particular employee. Many divorce practitioners treat cash balance plans just like defined contribution plans for purposes of settlement, only to find that cash balance plans are not as easily divided as defined contribution plans. In fact, many employees do not realize that their cash balance benefits are not the same as those in a traditional 401(k) plan.
Cash balance plans seem to be the most common form of hybrid plan, but there are also other types of “hybrid” plans that have their own quirks.
It is surprising how often settlement agreements contain statements such as, “Wife shall receive one half of Husband’s Pension Plan as of the date of the divorce, plus or minus earnings and losses from that date until the date the account is divided.” This presents a problem, since the concept of “earnings and losses” does not apply to pension (defined benefit) plans. As discussed above, payments under defined benefit plans do not fluctuate with the market, and thus there are no “earnings and losses.” Drafting an Agreement with the wrong language for the type of Plan being divided can have far-reaching consequences for your client.