There are numerous early retirement benefits a family lawyer must keep in mind when clients’ pensions are being divided.
By Mark E. Hills
Corporations, municipalities, and school systems (typical employers offering defined benefit or “pension” plans) are well into an age of downsizing. They often utilize early retirement as a “friendly” means of incentivizing employees to voluntarily join in such downsizing. The possibility of early retirement and its impacts on the division of pension benefits in a divorce must be carefully evaluated and planned for in preparation of QDROs/EDROs. The following are common early retirement benefits which must be considered when dividing a pension.
Buy-Outs
One well-known incentive is a “buy-out.” Typically, the employer will identify a group of employees as “eligible” for such a benefit enhancement, which is designed to augment the general early retirement provisions of the employer’s pension plan. Such “buy-outs” tend to be one-time events and may include: immediate lump-sum cash payments, adding a certain number of years to the employee’s age, adding a certain number of years to the employee’s service period, etc. Courts generally view such enhanced benefits as marital property since they are not earned by additional service by the employee. Thus, the coverture factor for the period of actual service has been applied to these benefits and properly drafted QDROs will address possible “buy-outs” in that fashion.
Early Retirement Supplements
Another incentive is a monthly pension “supplement” in which employers pay an additional monthly pension payment from the time of the employee’s early retirement until the employee reaches age 62 and becomes eligible for Social Security. As with a “buy-out,” these additional payments do not result from additional service by the employee and are thus subject to allocation in a QDRO based on the coverture factor for actual service. This is one of the limited scenarios in which incomplete QDRO preparation is likely to penalize the employee, rather than the alternate payee, and the QDRO must provide for elimination of such supplements for the alternate payee in proportion to and at the same time as the employee.
Early Retirement Subsidies
An early retirement subsidy is a benefit offered by an employer intended to induce employees to retire prior to their normal retirement age. The subsidy exists where the value of the benefit to be paid prior to an employee reaching normal retirement age (often age 65) is greater than the actuarial present value of the benefit payable at normal retirement age. If the employee satisfies age, service, or other requirements for early retirement, many plans reduce the monthly payment amount by less than the full actuarial cost of retiring early, and some do not reduce the monthly payment at all. For example, hypothetical 123 Corp offers an unreduced accrued benefit to anyone who retires at 60 years of age with at least 15 years of service. Thus, a 60-year-old employee with 17 years of service could receive the full accrued benefit that would otherwise have begun on her 65th birthday.
Failing to take an early retirement subsidy into consideration in preparing a QDRO can lead to a disastrous financial situation for a non-employee (or alternate payee) client. Assume 123 Corp employee Hector is 60 years old and has an accrued pension benefit of $3,000 per month. 123 Corp permits employees who are aged 60 with at least 15 years of service to retire with a fully subsidized accrued benefit. So, Hector (who has enough years of service) can retire now and collect the full pension he is entitled to at 65 years of age because 123 Corp is subsidizing his full, accrued benefit.
Hector and Maria divorce. The QDRO prepared by Maria’s attorney assigns 50% of Hector’s total accrued benefit, or $1,500 per month, to Maria. However, it does not address the subsidy in any fashion. When Maria contacts the plan administrator to begin receiving her benefit, she is told that she is entitled to only $750 per month because Hector is still employed and she is starting to receive the benefits five years before Hector’s normal retirement age. She can receive only an “unsubsidized” pension benefit that has been reduced to its actuarial present value.
Maria is in need of regular income, so she agrees to take the reduced benefit. Three months after Maria receives her first payment, Hector decides to retire early and starts to receive $2,250 per month ($3,000 – $750 paid to Maria). Since he was eligible for the subsidy, and because the QDRO was silent regarding allocation of it, Hector receives the full, subsidized benefit. As a result, Hector’s pension benefit is three times larger than Maria’s benefit.
Careful QDRO drafting must include early retirement subsidy language for the non-employee. Likewise, QDROs must include a provision requiring “recalculation” of the benefit in the event the employee does retire early. Such provisions can also apply to other benefits such as Cost of Livings Adjustments (COLAs), etc.
Aged-Out Subsidy
The 123 Corp hypothetical also highlights the need for attorneys to specifically counsel their alternate payee clients on the dangers of electing to receive pension benefits before the employee actually retires. In other words, careful QDRO drafting will not always save a client from himself or herself.
Assume the QDRO drafted by Maria’s attorney contained provisions to address the subsidy and recalculation of benefits upon early retirement. Further, again assume that Maria elected to receive her reduced pension benefit of $750 per month when Hector was 60 years old. If Hector continues to work until he is 65 years old and then retires, the QDRO clauses addressing the subsidy and recalculation of benefits upon early retirement would have no effect because there is no early retirement; Hector retired at normal retirement age and the subsidy “aged-out.” Thus, the reduced $750 monthly pension benefit Maria elected to receive would become permanently fixed and Hector would receive $2,250 of the fully accrued pension benefit ($3,000 – $750 paid to Maria).
Careful planning, preparation, and explanation of QDRO provisions to the client are necessary to avoid problems for clients and attorneys alike.
Mark E. Hills, Esq. is a partner with Varnum LLP, headquartered in Grand Rapids, Michigan with eight offices statewide. He is a Fellow in the Litigation Counsel of America and is chair of Varnum’s family law practice group. www.varnumlaw.com
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