The are 3 options when deciding how to divide a defined benefit plan in a divorce. Lump sum division, future share and reserved jurisdiction. For the purposes of this blog, we will discuss when dividing a defined benefit plan using the future share option. The future share option is defined as when the benefits are shared in the future between spouses.
There are 3 types of benefits:
- Fixed – this is based on a fixed percentage applied towards the employee’s compensation.
- Flat – the award would be a set amount at retirement, such as $2,500 every month.
- Pension Unit – This pension unit would be a percentage of the employee’s compensation that would then be multiplied by the number of years of service.
In order to receive a lump sum settlement, the benefit would need to be appraised. This appraisal consists of determining the amount of money necessary to invest today in order to get the benefit in the future. There are many different dynamics that can change this calculation. For instance, what is the interest rate that will be attained over the period of time before retirement. Other factors include the number of years before retirement, age at appraisal time, expected number of years to live, retirement ages, the amount to be received at retirement, beneficiary information, etc.
During a divorce, a QDRO or DRO is rquired to split a defined benefit plan. The QDRO or DRO would be written specifically for the particular pension plan. It is necessary to have the QDRO or DRO written, approved by the plan administrator and then signed off by the judge.
When selecting a future share option, it is necessary to determine how the benefit will be shared in the future. This could be done with a formula or a set dollar amount or percentage. The most popular method is the following formula:
- STEP1: determine how many years of service the spouse had in the company that contributed to the pension plan.
- STEP2: determine how many years the couple were married during those years.
- STEP3: use the number of years determined in STEP2 and divide by the number in STEP1.
- STEP4: multiply the number in STEP3 by 50%. However, this percentage could be any percentage to determine the marital component. This would be the percentage allocated to the non-employee spouse. The assets are usually split 50/50 to start, but there are factors and situations that may change the percentage split, but that is another blog.
- STEP5: once you have completed STEP4, this formula is then written into the QDRO or DRO to be used by the plan administrator to divide the assets once they are available at retirement.
Some benefit plans will allow the spouse to start receiving the benefits at their retirement instead of waiting for the employee spouse to retire. It’s important to know all your options before having the QDRO or DRO written. Don Desroches is a CDFA (Certified Divorce Financial Analyst) and is trained and experienced in splitting retirement funds.
Make sure to check out the blog about the retirement options that can be selected for the benefit plan
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