Retirement plans tend to be the largest marital asset in a divorce, in terms of value. Whether you are a family law attorney dealing with these issues on a daily basis, or an attorney who knows of (or is related to) a federal employee, here are some important issues to consider if the federal employee you know is going through a divorce.
By Tim Voit, Financial Analyst
Federal employees include, only in part, employees of the U.S. Postal System, IRS, FBI, Department of Labor, Transportation, FAA, and alike. This article touches on what is at stake with regard to retirement plan assets, how to protect the federal employees’ interest, or that of the former spouse depending upon who you represent, and whether to offset the value or divide the retirement plan by a court order (deferred distribution).
Issues related to federal pensions are many times not addressed adequately in the settlement agreement. As with any pension plan you either determine it’s value, for purposes of offsetting one-half of the marital value with other assets, or the pension is divided by a court order, QDRO or functional equivalent. There also tends to be some misunderstanding of what will be provided to a former spouse of a federal employee, pursuant to a court order division, and sometimes terminology and benefit options are confused with what is provided in the private sector. Government pension plans are exempt from ERISA (Employee Retirement Income Security Act of 1974) and therefore benefits which can be provided in a QDRO pertaining to private sector pension will not apply to government pension plans[i].
Legal malpractice also begins with the client’s expectations and when they do not receive what they expect, or what they are told they will receive, you as the attorney or advisor will have a problem difficult to resolve many years later.
There are also three major federal pensions most commonly encountered in divorce. They are the Civil Service Retirement System (CSRS), the Civil Service Offset plan, and the Federal Employees Retirement System (FERS). Each are very different in the calculation or payment of the benefit and which of the three a spouse will be participating in will likely be determined by the period of time the federal employee began federal employment. CSRS members receiver a larger calculated monthly pension, but no Social Security, while FERS receives both a pension benefit and Social Security. The CSRS Offset is a hybred where the initial monthly annuity is calculated using the (larger) CSRS formula however the monthly pension is reduced upon the commencement of Social Security. Key differences that can result in endless liability if one does not understand the differences.
Discovery Tip: If a federal employee makes a claim that they only have a TSP account, undoubtably they will have a FERS or CSRS pension benefit as well. CSRS/FERS participation is automatic. TSP is voluntarty.
What Are the Benefits to be Valued or Divided?
CSRS are defined benefit plans designed to pay out a monthly pension benefit for life with annual increases. What is confusing to some is that the federal pension plan does allow for small employee contributions, however employee contributions into a pension plan should not be confused with the value, as the plan is still designed to pay out a monthly pension benefit. This monthly pension benefit, for which the value pf the pension is derived from, most often far exceeds the amount of the employee contributions. The employee (only) contributions into a federal pension are not even related to the benefit that will actually be paid out and only serves to provide a small death benefit in the event the federal employee dies unmarried or shortly after retirement.
For example, a FERS participant claimed that their $4,000 employee contributions was the present value of their FERS pension, with almost 20 years of service, keeping in mind that the contributions for FERS participants are a great deal less than for CSRS participants. Therefore, $4,000 over 20 years would appear somewhat understated. In actuality, the participant may have accrued a monthly benefit of approximately $1,000 per month after 20 years payable at their age 60, or $12,000 annually, resulting in a lump-sum present value nearly ten (10) times the value of the employee account balance, or approximately $60,000 in present value terms depending upon their current age.
In reality, the government's portion of the contributions, including funding the annual cost-of-living adjustment (COLA), constitutes the majority of the overall value of the monthly pension benefit. This means that the employee contributions alone fall way short of the actual value, yet sometimes the employee account balance is the only information provided to the attorney. Therefore, it is incumbent upon the attorney representing the non-plan participant to ask of the plan "what is the participant's accrued monthly retirement benefit as of a certain date" and “when” or at what age can they commence their retirement benefits.
To determine the value of the federal pension the accrued monthly pension benefit has to first be determined, and as of a particular date, e.g. date of filing or date of separation. The federal monthly pension benefit, like many pension plans, is based on years of service and average annual salary, multiplied by a retirement factor. Again, the monthly pension is not based on employee contributions.
Practice Pointer: Often the federal government will provide “projected” benefits for retirement planning, assuming continuous employment up to retirement. If you’re not careful, and you accept these benefit amounts as the benefit to be valued or divided, you may have accepted or included benefits not yet accrued nor earned during the marriage. A problem if you represent the federal employee. Always look for a benefit that includes only the years of service up to the date of filing, or other agreed upon valuation date, and based on only the earnings as of that date.
Practice Pointer (II): The Office of Personnel Management (OPM) who administers the plan will NOT calculate accrued benefits as of certain date, which is almost always needed in a divorce. Nearly all other pension plan administrators will, however, OPM does not and therefore a competent expert or the federal employees employing agency will have to be consulted.
The primary difference between the FERS plan and the CSRS plan is that participants in the FERS plan also contribute to Social Security here in the U.S., while participants in the CSRS do not. This leads to the question of whether or not both plans should be valued in their entirety for purposes of property offset, since the Social Security benefits of the FERS participant, or other private plan participants for that matter, are not considered marital assets under federal law.
Caution: If the FERS or CSRS pension is divided by a court order, if the non-employee spouse is awarded "one-half of the employee contributions" and the participant elects to receive a monthly pension benefit instead of a refund of contributions, the non-participant spouse would receive nothing upon the participant's retirement, because the order awards contributions and not a portion of the annuity (monthly pension benefit).
For the CSRS pension benefit to be comparable to the FERS pension, and the fact that FERS employees also receive Social Security, the portion of the CSRS pension representing Social Security (enhancement) has to be determined and deducted from the CSRS value.
Tip: Although other cases exist around the country, this issue was addressed in Kelly v. Kelly, 198 Ariz. 307, 9 P.3d 1046 (Ariz. 09/14/2000) where the wife was in FERS and the husband was in CSRS. Here, the courts recognized that valuing or dividing a husband’s CSRS retirement benefit was also awarding a portion of his social security, or what he would have receive in equivalent benefits, yet without any adverse affect on the wife’s social security benefits.
One method of extracting out the enhanced portion of the CSRS benefits, otherwise referred to as the Social Security element, or benefits in lieu of Social Security, is to calculate what the Social Security benefit would have been had the participant contributed to Social Security during their years of participation in the CSRS plan. This entails compiling the participant's earnings history under the Plan, information often available through the participant's employing entity, and then proceeding to enter this information into the Social Security program to determine a Social Security benefit. A present value is computed based on this benefit and subsequently deducted from the overall present value of the CSRS plan.
Another approach is to determine the benefit that would have accrued had the CSRS plan participant been a FERS participant. The difference in the two calculated benefits would then give the attorney, or the courts, a clue as to how much of the CSRS is attributed to Social Security, or benefit in lieu of. The formula for computing the FERS benefit is quite simple, 1% x Years of service x average salary over highest 3 years. The CSRS is a little more involved but either formula is easily accessible via the Internet.
It should be apparent that the deduction of the Social Security element from within the CSRS pension benefit greatly depends on the circumstances of the case. Again, a classic example is when one spouse is in the CSRS plan and the other spouse is in the FERS plan, yet the Social Security benefits of the FERS spouse, or any spouse in the private sector, is not considered in the equitable division of marital assets. However, nor should the entire value of the CSRS pension be considered because of this issue of the Social Security element, or enhancement. It should also be noted that another aspect of the plan federal employees may participate in, is the CSRS Offset. CSRS Offset participants do contribute to Social Security, much like FERS, however upon commencement of Social Security the CSRS benefit is reduced, or offset, by the amount of Social Security received, the opposite of what occurs when one is a full CSRS participant.
As with most pensions or retirement assets in divorce, they should first be valued to determine whether or not the participant can retain the entire pension without the need for drafting an Order to divide the benefit, with the objective being to provide for an equitable distribution of all retirement benefits. Valuing the monthly benefit, for either FERS or CSRS, is performed much the same way as any traditional defined benefit pension, however, factoring in the annual cost-of-living-adjustment should not be ignored. For instance, a 2 to 3 % COLA increase can increase the lump-sum present values upwards of approximately one and a half times, a valuable aspect of the Plans sometimes overlooked by evaluators.
Court Orders Acceptable for Processing (COAPs) & Court Ordered Sharing of a Pension: Lastly, with regard to using a court order to have the pension benefits paid to a former spouse of the U.S. federal employee, a few issues are worth pointing out. The FERS and CSRS plans do not accept the same terms and conditions as QDROs. QDROs apply to private industry retirement plans, although some government plans accept the term or title “qualified domestic relations order”. The court order still cannot provide the same type of benefits as a QDRO, except for the Thrift Savings Plan.
If dividing the accrued pension benefit by a court order, remember that the plan is designed to pay a monthly pension benefit, therefore the order should be drafted with emphasis placed on the monthly amount to be paid. Although the FERS and CSRS plan allows for a refund of employee contributions, this is rare since doing so would forfeit all of the employer or government’s paid benefits. You may consider stating that the employee is not to elect a refund of employee contributions. Also keep in mind that if the employee dies all benefit payments will stop unless the non-employee spouse is also awarded survivor benefits, or a portion of the survivor annuity based on their share. The federal government will also not accept court orders from other countries, so the attorney in any country outside the U.S. will have to have the court order entered here in the U.S. or the pension valued and more marital assets awarded to the non-employee spouse in stead of sharing in the pension.
Consider various valuation strategies to maximize your client’s position.
Pension and QDRO expert Mark Altschuler talks about common mistakes when valuing defined benefit and defined contribution plans – including partial offsets and tax consequences – with Family Lawyer Magazine publisher Dan Couvrette.
Properly dividing military pensions requires an understanding of tax issues specific to military pension garnishment as well as an ability to differentiate alimony from income.
Tim Voit is a Financial Analyst and founder of Voit Econometrics Group, Inc, a forensic economics advisory firm. Voit advises law firms around the country on QDRO related issues and the valuation of retirement plans in divorce and is author of Retirement Plan Benefits & QDROs in Divorce.
[i] The federal pension plans, Florida Retirement System, and municipal pension plans are exempt from the Employee Retirement Income Security Act of 1974 (ERISA) and the Retirement Equity of 1984 (REA) under Sections 1003(b)(1) and 1051 of title 29, United States Code because the plans are considered "governmental plan" as defined in Section 1001(23) of title 29, United States Code