This week’s financial tip comes courtesy of Stephanie Farrar, MBA, CDFA. Stephanie is a practicing CDFA in both Florida and Washington State. She works with couples, individuals, mediators, and attorneys to provide financial expertise during divorce and is trained and experienced in all financial aspects of divorce, including retirement plan valuation, executive compensation, support guidelines, and tax optimization of property settlements.
Three Pension Lessons Learned the Hard Way
In divorce, a pension can often be the most valuable retirement asset owned. They are also fairly complex in that a value needs to be calculated, the percentage of community property may need to be determined, and the rules around dividing these assets need to be followed to a tee.
People get sideways with pensions during a divorce all the time, so here are three lessons that can help save you time and money in your divorce:
Lesson #1 – Don’t leave your money on the table!
While there are many ways in which money can be left on the table during divorce, the most common I see with pensions is simply not knowing they exist. I cannot even begin to tell you how many people have come to me for financial consulting services and been completely unaware that they or their spouse even had a pension.
In fact, one of my financial planning clients was super surprised and excited to learn he had not one, but three pensions from previous employers. This news completely changed his financial plan for retirement!
And recently, I was consulting on a settlement where the wife insisted she did not have a pension. Much to her surprise, she did. That knowledge turned out to be pivotal in calming her financial fears and resolving her divorce settlement more quickly.
How can this possibly happen?
It happens because pensions are a promised future benefit rather than an individualized account with money in it today. This makes periodic account statements unnecessary until you get close to your retirement age.
While corporate pensions are certainly becoming a thing of the past, most federal, state, and city employees still have them including civil servants, teachers, military personnel, postal workers, librarians, etc. And while many corporations have frozen or modified their pensions, tenured employees were frequently grandfathered into benefits such as Boeing, Alaska Airlines, Seattle Times, Coca-Cola, and the list goes on.
Lesson #2 – Beware the pension valuation trap!
Pension valuation is a fairly complex set of present value calculations based on variables such as age, retirement date, life expectancy, discount rate, and future benefit.
So, where’s the trap?
First, the future benefit estimate is either provided by the plan sponsor or calculated based on a specific formula. The estimate is presented as a future income stream during retirement rather than a current asset value. Pension plans do not typically calculate the present value of the pension for participants, which is why a periodic statement is not provided. Pension plans must be valued by a qualified pension valuation expert.
To make matters worse, retirement statements can be quite confusing. For instance, some government plan statements will disclose employee contributions made to the plan to date, but this is not the true value of the pension. And more and more frequently, we see defined contribution account statements that illustrate a future income estimate based on the current savings balance, but that is not a pension benefit estimate.
Obtaining a pension benefit estimate from your plan sponsor is usually easy enough to accomplish either online or by phone if you understand how to request the correct information. Once you have a benefit estimate, you’ll want a qualified valuation expert to calculate the current value of the pension and determine any community versus separate property components.
Lesson #3 – A bird in the hand may be worth two in the bush!
Many people assume that a pension has to be divided upon divorce, but that is a somewhat complicated process and not necessarily true.
First of all, dividing a pension requires a legal document that is pre-approved in draft by the pension plan sponsor, ordered by the court, and then submitted back to the plan sponsor for implementation. These orders are commonly referred to as Qualified Domestic Relations Orders (QDRO), although alternative names are used for military and some government plans. This is not a timely process, as you can imagine.
And, any assets awarded in the division of a pension must comply with the pension plan provisions and will be applied to both parties post-division.
As an example, when there is an age attained requirement for the employee spouse, such as age 65, the same date will typically be imposed on the non-employee spouse as well. So, if the employee spouse decides to wait until age 75 to start their pension, the non-employee spouse may very well also be delayed. Therefore, it is important to understand the provisions of the plan and how they might affect your plans for retirement before pursuing a division.
A more efficient option may be to pursue an asset offset. While this still requires that a pension be valued, the pension award is instead offset by allocating other assets such as home equity or other retirement assets in its place. The pension does not get divided, but this approach allows for a clean break between the parties. The employee spouse will have the entire pension and can retire at will. And the non-employee spouse can re-title the awarded offset assets and pursue their own personal financial goals.
There are financial risks to either of these approaches and it is worth consulting with a Certified Divorce Financial Analyst? to better understand the risks and help determine the pension settlement strategy that will work best for your specific situation.
