For many couples going through divorce, the largest assets are the house and retirement accounts. But a traditional pension can be especially difficult to understand because, unlike a 401(k), there may not be an account balance sitting on a statement.
Instead, a pension may promise a monthly income beginning at retirement and continuing for the rest of the employee's life.
That raises some important questions during divorce:
These questions become particularly important in a gray divorce, when retirement may be only a few years away and there may be less time to recover from financial mistakes.
A pension earned during a marriage may be marital property in Minnesota.
Minnesota law includes vested public or private pension benefits or rights within its definition of marital property when acquired during the marriage and before the applicable valuation date.
That does not necessarily mean the entire pension is marital.
If an employee began participating in a pension before the marriage, for example, there may be both a marital and a non-marital component. Determining those portions can require looking at employment dates, pension participation dates, the marriage date, the valuation date, and the specific terms of the pension plan.
This is one reason it is important to identify retirement assets early in the divorce process rather than simply looking at the monthly benefit shown on a pension statement.
One of the first things I explain to clients is that not all retirement plans should be analyzed the same way.
A defined contribution plan, such as a 401(k), generally has an identifiable account balance. If a 401(k) statement shows a value of $500,000, there is an actual investment account with approximately $500,000 in it, although taxes and other considerations still matter.
A traditional defined benefit pension is different.
Instead of promising an account balance, the pension typically promises a future benefit. For example, an employee might be entitled to receive $4,000 per month beginning at age 65 for the remainder of the employee's life.
So what is that pension worth today?
That is where pension valuation becomes important.
The present value of a pension is an estimate of what the future stream of pension payments is worth in today's dollars.
This isn't as simple as multiplying the monthly pension by someone's life expectancy.
A pension valuation may consider factors such as:
Minnesota law specifically provides a procedure for valuing pension benefits and permits the use of a qualified person experienced in pension valuation to determine the present value of pension benefits that are marital property.
In some divorces, obtaining an actuarial pension valuation can provide valuable information before the parties decide how to divide their assets.
Not necessarily.
There is an important difference between valuing an asset and dividing the asset itself.
Suppose a marital pension has a present value of $400,000.
One possibility may be to divide the pension so each spouse receives a portion of the retirement benefit.
Another possibility may be for the employee spouse to retain the pension while the other spouse receives additional marital assets.
For example, a couple might consider whether one spouse could retain more home equity or investment assets in exchange for the other spouse retaining more of a pension.
But this is where careful financial analysis matters.
A $400,000 pension is not automatically financially equivalent to $400,000 of home equity, cash, or investments.
Two assets with identical values on a marital balance sheet can have very different financial characteristics.
Consider:
$400,000 of home equity
versus
$400,000 of pension present value.
The home may eventually be sold, may appreciate or depreciate, requires ongoing expenses, and may potentially have tax consequences.
The pension may provide taxable income over many years and may depend upon the employee's lifetime and the benefit option selected.
Similarly, $400,000 in a traditional retirement account generally represents pre-tax dollars, while $400,000 sitting in a bank account represents after-tax dollars.
This is why I encourage divorcing couples to look beyond simply making the two columns on a marital balance sheet equal.
The goal should be to understand what those assets will actually mean for each person's financial future.
A Qualified Domestic Relations Order, commonly called a QDRO, is a court order used to assign certain retirement-plan benefits to another person, generally referred to as the alternate payee.
A QDRO may be needed when retirement benefits are divided as part of a divorce.
The exact language required can vary significantly from one retirement plan to another. The Minnesota Judicial Branch does not publish a standard QDRO form because the language necessary to divide a retirement plan is plan-specific.
The plan administrator may have model language or procedures that should be reviewed when the QDRO is prepared.
Not every retirement arrangement is divided through the same process, so it is important to determine exactly what type of retirement plan is involved.
With certain retirement plans, there are two broad approaches that may be considered.
Under a separate-interest approach, a portion of the participant's retirement benefit is assigned to the former spouse as a separate benefit.
Depending upon the plan, this may give the former spouse greater independence regarding when and how the assigned benefit is received.
Under a shared-payment approach, the former spouse receives a portion of the payments made to the employee spouse.
The appropriate structure depends upon the pension plan, the parties' circumstances, and the terms permitted by the plan.
This is another reason the plan documents should be reviewed before the divorce agreement is finalized.
Survivor benefits are one of the pension issues that should not be overlooked.
Imagine that a former spouse expects to receive part of an employee's pension for the rest of the employee's life.
What happens if the employee dies?
The answer depends upon the pension plan, the benefit election, the divorce decree, and any applicable retirement order.
Some pensions provide survivor-benefit options that can continue payments after the participant's death. However, survivor benefits can affect the amount of the monthly pension and may have specific requirements or deadlines.
The U.S. Department of Labor specifically cautions that survivor benefits should be considered when retirement benefits are divided through a QDRO.
This issue can be particularly important for someone divorcing later in life who is depending upon pension income as part of his or her retirement plan.
If pension benefits were earned both before and during the marriage, the pension may contain both marital and non-marital components.
Determining the marital portion isn't always as simple as looking at the current pension value and estimating a percentage.
The analysis can depend upon the type of pension, the years of service, when benefits accrued, the plan formula and Minnesota law.
If a non-marital claim is being made, documentation becomes especially important.
Retirement assets should also be evaluated on an after-tax basis when appropriate.
Pension payments are generally taxable income to the person receiving them, subject to the tax characteristics of the particular plan and benefit.
Likewise, traditional 401(k) and IRA assets are generally pre-tax retirement dollars.
That can make comparisons between retirement assets and after-tax assets misleading if taxes aren't considered.
For example, receiving $300,000 of additional pre-tax retirement assets isn't necessarily economically equivalent to receiving $300,000 in cash.
The difference can become particularly significant when a couple has accumulated substantial retirement assets.
If either spouse has a pension, gather information about it early in the divorce process.
Useful documents may include the most recent pension statement, benefit estimates at different retirement ages, the Summary Plan Description, employment and plan participation dates, available survivor-benefit options, information regarding early-retirement benefits, and any documentation concerning benefits earned before the marriage.
In Minnesota, pension plan information may also be available from a plan administrator in connection with a pending marriage dissolution.
Having complete information before negotiating can help prevent a couple from making decisions based on an incomplete understanding of the pension.
Retirement assets deserve special attention in a gray divorce.
A couple divorcing in their 30s may have decades of employment ahead of them to rebuild retirement savings.
Someone divorcing at 55, 60 or 65 may not.
At that stage of life, decisions involving pensions, Social Security, retirement accounts, housing, spousal maintenance, taxes and healthcare are often interconnected.
For example, keeping the house may feel like the safest choice emotionally, but doing so could require giving up retirement assets that would otherwise produce income for decades.
Likewise, accepting retirement assets without understanding their tax treatment may leave someone with less spendable retirement income than expected.
That is why I believe the conversation should go beyond:
"Is the property division equal?"
A better question is:
"What will each person's financial life look like after the divorce?"
In a mediated or collaborative divorce, a financial neutral can help both spouses understand the financial implications of different settlement options.
That may include:
A financial neutral does not replace each party's attorney or provide legal advice. Instead, the financial neutral helps make the financial information understandable so the couple and their attorneys can make informed decisions.
Not necessarily. How a pension is characterized and ultimately divided depends on the facts of the case, including when the pension benefits were earned, whether there is a non-marital component, the parties' overall property division and any agreement or court order.
Potentially. Couples can consider different ways of dividing their overall marital estate. One spouse might retain a pension while the other receives different assets, provided the parties reach an agreement that works within their divorce settlement.
Before making that trade, however, both spouses should understand the pension's value and the financial characteristics of the assets being exchanged.
Not every divorce requires one.
If the pension will simply be divided according to an agreed formula, a present-value calculation may not always be necessary.
But if one spouse wants to retain the pension and offset its value with other assets, determining an appropriate present value can become much more important.
It depends upon the pension plan and how the divorce documents and retirement order address survivor benefits.
This should be investigated before the divorce is finalized rather than after a death occurs.
No. Different types of retirement assets are governed by different rules and procedures. A QDRO is commonly used for certain employer-sponsored qualified retirement plans, but not every retirement asset is transferred using a QDRO.
Generally, the person receiving taxable pension benefits is responsible for the income taxes associated with those payments, although the specific tax treatment depends upon the retirement plan and how the distribution is structured.
A pension can be one of the most valuable—and most misunderstood—assets in a Minnesota divorce.
Before agreeing to divide a pension, keep it, or exchange it for another asset, make sure you understand:
How much of the pension is marital? What is it worth? How will benefits be paid? What happens at death? What are the tax consequences? And how does the decision affect each person's retirement security?
Those questions become especially important for couples divorcing after 50.
At Divorce Smart, I help individuals and couples understand the financial side of divorce through mediation, collaborative divorce and financial-neutral services. My goal is to help clients understand their options and make informed financial decisions about their future.
This article is for educational purposes only and is not legal or tax advice. Every divorce and retirement plan is different. Consider consulting with appropriate legal, tax and financial professionals regarding your individual circumstances.
Check the background of your financial professional on FINRA's BrokerCheck. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
