Valuation of Pensions in Divorce
Defined contribution plans, such as 401(k)s, are easier to value than defined benefit plans. Defined benefit plans are more difficult to divide because the payout is based on a plan formula, not an individual account, and settlements may have to consider post decree increases, which is a frequent area of contention.
In a divorce, the value of a defined contribution plan is easy to calculate: it is simply the balance of the account. However, the valuation date - that is the date when the plan is valued for divorce division - is very important because, unlike the defined benefit plan (the old-fashioned company pension), the value of a defined contribution plan can and does fluctuate dramatically after a couple separates but before they divorce. Millions of Americans who imagined that a sky-high Dow-Jones average insured them of easy golden years learned this the hard way when the stock market crash wiped out their retirement savings as part of the Great Recession.
In a defined contribution plan, monthly or quarterly statements show the individual's account available to be divided. Defined contribution plans cash value today: the dollar value of the account. A portion of the defined contribution plan can be transferred to the former spouse without any tax consequences by establishing a trustee-to-trustee transfer of the funds to an Individual Retirement Account (IRA). Or the account may be divided. Some companies allow for the plan to be divided so that the former spouse also now has an account.
By comparison, determining the value of a defined benefit pension requires that it be appraised to determine its present value. This requires the services of an actuary specializing in such calculations. Normally, one of three methods is used to divide defined benefit pension plans: 1) present value or cash out method, "which awards the non-employee spouse 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"; 2) "deferred division' or future share...where no present value is determined [and} [e]ach spouse is awarded a share of the benefits if and when they are paid" and 3) "reserved jurisdiction,' whereby the court retains the authority to order distribution from the pension plan at some point in the future, [normally] ... a last resort, as it leaves both spouses in limbo with regard to planning for their future."
As it applies to a defined benefit pension, the calculation of worth often means the present value, or the time value of money. Present value is the current worth of income to be received in the future. Present value describes the amount of money which would have to be set aside of that sufficient funds are available to pay out the pension amount throughout the employee's years of retirement.
As it applies to the middle aged woman facing divorce, the failure to appreciate the enormous present value of a husband's pension can lead to disastrous decisions in divorce negotiations. This can become very important for a woman facing the prospect to reentering the job market indifferent to her stale work skills.