This retirement benefit can save your divorcing client money. However, situations differ, requiring you to run the numbers before you advise the client.
By Ginita Wall, CPA/CFP
When dividing pension plans in divorce, we generally use the time rule method, also known as the Brown formula (the time the employee worked under the plan during marriage, divided by the total time the employee worked under the plan). The Qualified Domestic Relations Order (QDRO) will specify the numerator, and once the pension goes into pay status, the administrator will calculate the payments for each party. As an alternative, the present value of the future retirement benefit can be calculated by an actuary and awarded to the employee, with other assets going to the spouse.
But it’s a different story if the employee is already retired. ERISA requires that a married retiree elect a survivor benefit, so the retiree receives a smaller monthly retirement benefit during his lifetime and then the spouse receives an income for the remainder of her life. This election of the survivor benefit is often irrevocable, even in divorce.
Retirement Benefit Can Save Your Divorcing Client Money: An Example
Here’s an example: A single retiree would receive $2,500 a month, but a married retiree electing a survivor benefit is receiving only $2,000 a month, and upon his death his widow will receive $1,000 for the rest of her life.
Now that they are divorcing, he is upset that he is receiving $500 less per month than he would have if they had divorced before he retired. He’s especially irked that when he dies the plan will pay his ex-wife $1,000 a month for the rest of her life. You review the plan and find that even though they are divorcing that election can’t be changed.
Here’s a solution: Charge the former wife with the value of the survivor benefits in the division of assets. Using the same methodology as used to value the husband’s remaining payments, the actuary will calculate the value of survivor benefits by estimating the husband’s expected date of death and the wife’s projected longevity from that point forward. This is the step that is often overlooked, and if your client is the retiree, it can save him thousands.
Continuing our example, let’s assume that the value of the retiree husband’s pension payments is $300,000, and the wife’s survivor benefit is worth $100,000. The property division would charge the husband with $300,000 and the wife with $100,000, so the husband would owe the wife $100,000 to equalize. That could be paid from other assets, or she could be awarded one-third ($100,000 /$300,000) of the husband’s pension payments using a QDRO. So now, instead of the $2,000 he has been receiving, he will get 2/3, or $1,333, and she will get the remaining $667 during his lifetime and $1,000 survivor benefits after his death.
The husband may still think this is a lot, but his liability to his ex-wife has actually been reduced. Rather than owing her 50% of the $2,000 a month he has been getting, he owes her only $667.
But what if your client was ready to retire, and he had divorced just before he began getting payments? With no spouse, he would have been eligible for the higher payments of $2,500. But after dividing the pension plan in half, his retirement benefit would have been only half, or $1,250 a month. Though not a big monthly difference, over a 20-year retirement he will collect almost $20,000 more by having waited to divorce until after retirement. Caution: each situation is different, so run the numbers both ways before you advise the client.
Based in San Diego, CA, Ginita Wall, CPA, CFP®, was named one of the top financial advisors in the country by Worth Magazine for eight years in a row and is a member of the advisory board for Divorce Magazine. She provides forensic accounting and financial guidance to men, women and their attorneys before, during and after divorce. Ginita is also co-founder of WIFE and the Money Clubs, and she is also originator of the acclaimed Second Saturday program — What Women Need to Know About Divorce.