Glossary Of Pension Evaluation Terminology for Divorce Cases
A participant in every type of pension plan has an accrued benefit. In an individual account plan (defined contribution plan), the accrued benefit is the balance in the participant's account. Once a year, and in some plans more often, the participant receives a statement of his or her account balance. The account balance generally increases every year unless there has been a substantial decline in plan assets due to investment losses. In a defined benefit pension plan, the pension benefit is defined by a formula in the plan. In most plans, the benefit increases each year as pay and years of service increase. The plan records contain the participant's accrued pension benefit for each year, which is determined as of the plan anniversary date. By referring to past records, or by a calculation using prior data for an individual, an accrued benefit can be calculated as of a past date, such as the date of marital separation or filing of the divorce complaint. A plan may not be able to provide the exact accrued benefit as of a specific date, but assuming the benefit changes one year at a time, or ratably by month over a year, the exact date benefit is not essential. If future salary increases are ignored, or if they are projected mathematically, an accrued benefit may be fairly estimated at any desired future date, such as the normal retirement date.
Accrued Benefit Fraction
ERISA requires that a defined benefit pension plan contain a stated method for determining the accrued benefit of a participant at least once a year. The most common method uses the accrued benefit fraction. The numerator of the fraction is the length of credited service in the plan, under the plan's definition of service, up to the date being measured. The denominator is the potential length of credited service in the plan if the individual continues working to normal retirement age. The accrued benefit fraction is then multiplied by the expected pension benefit at normal retirement age. Future pay increases are not included. This is a service-based approach that counts prior pay history as defined in the plan up to the date being measured and assumes that future pay remains unchanged.
Accrued Benefit Reduction
In a qualified ERISA defined benefit plan, a participant's accrued benefits normally may not be reduced. However, with special permission from the IRS and the PBGC, a plan amendment may reduce benefits already accrued. The operation of combined limits for an individual who is a simultaneous participant in two plans sponsored by the same employer can reduce an already accrued benefit in the pension plan. The reduction would depend on the terms of the two plans regarding which plan will suffer a reduction if the participant reaches the combined maximum allowed by pension legislation and IRS regulation.
The valuation age of the pension plan participant is a vital element needed for determining the present worth of a defined benefit pension plan. There are four generally recognized methods of computing age for this purpose: (1) age last birthday - the person's actual attained age; (2) age next birthday - the age the person will be at the next birthday; (3) age nearest birthday - the person's age within six months, past or future (the age generally used in pension valuations); and (4) exact age - the person's age on the valuation date, in years and fractions of a year or months. The difficulty with the fourth method lies in entering a table of rates by age.
An employee's age is a critical element in determining the present value of a pension in a defined benefit pension plan. In one case, an individual who applied for retirement revealed that her true age was 65, not 55 as shown on her employment records. She had misrepresented her age when she was hired. Because the pension plan was small - only 19 participants - the plan actuary contended that the difference between the employee's true age and her reported age was actuarially significant and to the detriment of the plan. The pension plan postponed the commencement of the employee's benefits, relying on the "wrong" age shown on the plan books, and its action was upheld by the court. Nass v. Local 810 Staff Retirement Plan, 515 F. Supp. 950 (S.D.N.Y. 1981).
An employee misstatement of age affects the person's eligibility for retirement and the actuary's computations of the person's liabilities and contribution requirements. The following is a standard list of acceptable proofs of age for pension purposes: birth certificate, baptismal certificate or signed statement on church records, United States Census Bureau notification of birth registration, hospital birth record or certificate, foreign church or government record, attending physician's or midwife's signed statement, Bible or family record, certified naturalization record or immigration papers, military records or school records, passport, insurance policy, labor union certified records, voting records, and marriage license or certificate.
Refers to any risk, such as in insurance, or contingency, such as death or disability, that impacts the funding of a pension plan's ancillary benefits.
Alienation or Attachment of Pension
ERISA prohibits attachment, alienation, or garnishment of pensions. However, many states have laws that include pensions as marital property. Thus, when a state court serves an attachment order on a pension plan, ordering the plan trustee to make a payment of plan funds to a spouse, ex-spouse, or anyone who is not a plan participant, the trustee is caught between the requirements of state and federal law. Relief is offered by the Retirement Equity Act of 1984 (REA), which created the concept of a QDRO. A QDRO allows attachment if certain steps are followed, although a general creditor usually cannot attach pension benefits even in the case of bankruptcy. However, a Keogh plan or an IRA may be attachable in bankruptcy in some situations. An ERISA plan that covers only one employee, such as the owner of the company, may be vulnerable to bankruptcy attachment.
Alimony considerations may be taken into account with a pension plan valuation or pension plan deferred distribution if so ordered by the court. The court may wish to consider the need for reduced alimony or none, if the pension's present value is used in immediate offset of other marital assets. For example, if the spouse who would otherwise receive alimony receives substantial property in lieu of a piece of the pension, there may be no need for alimony. If there has been immediate offset of present value plus alimony, the court should distinguish between the spouse's income with and without the pension to avoid a form of double-dipping. That is, once the pension distributions start it may be inequitable to include the pension as income for purposes of affordability of alimony payments if that pension has already been accounted for in an earlier settlement. However, in a Pennsylvania case, the court held that the ex-husband's pension income could be considered when determining alimony even if he was awarded the entire pension in the divorce.
McFadden v. McFadden, 563 A.2d 180 (Pa.Super. 1989).
A plan benefit or coverage in a plan that is considered incidental to the larger program and the advantage or cost of which is not significantly material to the total program's advantages or costs. Even when a benefit adds significantly to the cost of a plan, such as an extremely generous disability benefit, the benefit is considered an ancillary benefit if it is not in and of itself a benefit that serves the primary purpose of the plan.
A series of regular payments in equal dollar amounts, payable once a year for a predefined period. Most pension annuities are payable monthly rather than annually. Payments may be at the beginning of each payment period (the first day of each month) or at the end. The period of payments may be for the annuitant's lifetime, over the joint lifetime of two people, for a specific time period regardless of a person's life, or for a person's lifetime with a minimum number of guaranteed payments. An annuity may provide for death benefits with more than one beneficiary or for a death benefit payable only if a specific prenamed beneficiary is the survivor. A straight lifetime annuity is the most common form in a pension plan. It stops at the death of the retiree, with no survivorship benefits.
A policy purchased from an insurance company. The policy provides for annuity payments to an individual, with varying terms and conditions, in a certain amount, as stated in the contract. A pension plan may buy an annuity for a retiring participant in lieu of the pension fund making the monthly pension payments. The advantage is that the insurance company takes over all of the paperwork and administration and bears the mortality risk or gain. The disadvantage is that the pension fund must part with a large sum of money to buy the contract. If an annuity has been purchased by a plan for a participant, the annuity retains the tax shelter that the plan had, and the payments are taxable to the beneficiary as received. If a QDRO is in place before the annuity is purchased, the plan may purchase an annuity for the alternate payee as well as for the retiree. If a QDRO is ordered after the annuity is in place, the insurance company's legal department should be consulted to see if the insurer will administer the QDRO directly or if it requires the QDRO to be processed through the plan first.
The basic purpose of an annuity contract is to provide annuity payments in the future. However, insurance companies may market their annuity products as investment vehicles. A deferred annuity may be sold for a particular cash price today, with the annuity payments to commence at some future date, and with a minimum guarantee of tax-sheltered internal investment growth. The investment growth would increase the eventual annuity payout if such growth amounts to more than the underlying interest assumption of the basic annuity. The selling agent generally will emphasize the potential growth and recommend a lump-sum payout at maturity instead of a series of monthly annuity payments. In the early years, these types of contracts usually have high surrender charges and can be expected to cost more - i.e., have a larger purchase price - than a straight annuity contract. Conversely, a straight annuity contract promises an exact payout at the specified future date, regardless of investment performance. When pension plans use annuities, they are usually straight rather than investment annuities.
An antenuptial agreement is presumed valid if it provides that the future husband and wife have fully disclosed to one another the extent of their assets and the extent of possible marital rights. Cooper v. Oates, 629 A.2d 944 (Pa.Super. 1993). The case did not involve a pension, but it raises the question whether potential pension rights and values should be mentioned in an antenuptial agreement. Should the document include references to ERISA if one or both of the prospective spouses are employed and covered by a pension plan? Should an actuarial valuation of prospective pension values be listed in the full and fair disclosure of possible assets? If neither party is covered by a pension plan prior to the marriage, should the agreement mention potential future coverage? Because court cases involving marital agreements leave many questions unanswered, the attorney in family practice should consider the potential pension issues in advising clients.
Assignment of Pension
In most cases, a retiree whose benefits are in pay status may assign or alienate the right to future benefit payments provided that (1) the assignment or alienation is voluntary and revocable; (2) the amount does not exceed 10 percent of any benefit payment; and (3) there is no direct or indirect defraying of plan administration costs. Although for federal purposes the assignment must be revocable, this is not always the case at the state level. For example, a pensioner in a nursing home in Pennsylvania signed over his pension benefits so that payments went to the nursing home. He was married, and his wife, who was also elderly, had no pension of her own. He sued for relief to provide one-half of his pension to the nursing home, preserving one-half as marital property. He argued that in the event of divorce, one-half of his pension would go to his wife. The court denied his request, affirming that the entire pension was available to pay for nursing home care and should be so used; a potential marital property interest that might become an asset in divorce is incidental and does not govern.
Buck v. Commonwealth of Pa., 566 A.2d 1269 (Pa. Commw. 1989).
A benefit formula that gives more weight to later service in a person's career with the employer under the plan in a defined benefit pension plan. For example, the pension benefit may accrue over time at 1 percent of pay for each of the first 10 years of service, plus 1.25 percent for each of the next 10 years, plus 1.5 percent for the balance of years of service in excess of 20 years. In theory, any pay-based defined benefit pension plan may be thought of as being back-loaded under the assumption that a person's pay will increase with time and, therefore, later years of pension benefit will be based on higher pay amounts.
Cash-Balance Pension Plan
A special kind of qualified ERISA defined benefit pension plan that reports the value of the current accrued pension to plan participants each year. Upon termination of employment with a vested pension, or retirement, the employee may request a lump-sum payout in lieu of a monthly pension.
Cash or Deferred Arrangement
A cash or deferred arrangement (CODA) is a feature of a qualified 401(k) plan under ERISA. When a plan has this feature, the participant has a choice each year of whether to receive a specified amount in cash as income or to defer the amount into the individual account in the plan as a tax shelter.
A plan's vesting schedule is called cliff vesting when full vesting is obtained upon the completion of a specified period of service, such as ten years. In ten-year cliff vesting, if an employee leaves with nine years of service, all benefits are forfeited. However, at ten years or more, vesting is 100 percent. Typical cliff vesting is three or five years in single-employer plans and ten years in multiemployer plans.
See Cost of Living Adjustment. Typically adjusted annually based on th plans performance and funding. COLA must be inherent in a plan and a product of all member's retirement formula to be factored in a pension evaluation.
Collectively Bargained Plan
A plan established and maintained between one or more employers and one union or collective bargaining unit under a collective bargaining agreement. This type of plan was formerly called a Taft-Hartley plan. If more than one employer is involved in the collective bargaining agreement, the plan is called a multiemployer plan. Collectively bargained plans are subject to ERISA (or the PBGC if the plan is a defined benefit plan) and the Multiemployer Pension Plan Amendment Act of 1987. If only one employer (including affiliates) is required to contribute to the plan, the plan is treated in the same way as plans that do not cover union employees are treated.
Common Law Marriage
Common law marriage may be recognized in some states, but it is difficult to secure pension rights for the putative "spouse." Courts are reluctant to divide a pension as marital property when there has not been a bona fide marriage. The federal government has denied Social Security benefits to a "widow" of a common law husband. In a case reported in The Wall Street Journal (Dec. 31, 1990), a 74-year-old woman began receiving benefits when her husband died in 1985. However, upon routine paperwork processing, the woman appealed on the basis of a common law marriage, but she lost in federal appeals court. Similarly, a New Jersey court ruled that cohabitation without formal marriage did not give a woman any rights to a man's pension. Wajda, 570 A.2d 1308 (N.J.Super.Ct. 1989). In a Pennsylvania case, a woman was denied survivor's benefits from the pension plan of her deceased husband because she was not legally married to him. Flagg v. Allied Signal Inc., as reported in the Pennsylvania Law Journal-Reporter, April 16, 1990.
In community property states, pension rights are not subject to the terminable interest doctrine, that is, the rights do not stop upon death but remain available for distribution after the death of a spouse. Otherwise, death of either spouse would end the community share of marital property interest in the pension. Chirmside v. Board of Admin. of Public Employees Retirement System, 143 Cal.App.3d 205 (May 20, 1983).
The community property states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. (Mississippi is the only state that distributes property by title.)
Comparison of Pensions
In settling the property in a divorce where both husband and wife have pensions from their respective employers, it is sometimes suggested that each retain his or her own pension with no further investigation. This will almost always be a mistake. The plans may be of different types (e.g., defined benefit, defined contribution) and may have different retirement ages. The spouses' salaries and work histories are usually different, and the benefits provided are probably different. The only correct way to compare pensions is to compare their present values at the same point in time, when all of the variables can be accounted for.
The Internal Revenue Service Restructuring and Reform Act of 1998 (RRA '98) includes provisions extending attorney-client privileges to Enrolled Actuaries in the performance of certain actuarial duties under ERISA. The law protects confidentiality between actuary and client to the extent that the actuary is an Enrolled Actuary, authorized to practice with respect to specified IRS duties and responsibilities. An Enrolled Actuary's confidentiality is limited to issues involving the qualification of employee plans, the deductibility of employer contributions, the determination of funding requirements for defined benefit pension plans, preparation of annual IRS filings, advising with respect to the drafting of QDROs, and a long list of other minor duties under various IRS code sections. The privilege of confidentiality may be used in noncriminal process with the IRS or in federal court, but it does not apply to other regulatory bodies or in state courts. The confidentiality privilege for IRS matters is not blanket coverage, however, and any person seeking to use it should confer with counsel beforehand.
In a defined benefit pension plan, the employer makes contributions for the covered group. Contributions are not made on an individual basis, and a pooled fund of assets provides benefits when they come due. A defined benefit pension plan may allow employee contributions. If so, a separate account is maintained for employee contributions and investment growth thereon. The plan may include the employee contributions (if any) in its funding of benefits, providing no additional benefits, or the employee money may be used to increase benefits. A plan with employee contributions should be reviewed to see if benefits are affected.
In a defined contribution plan, employer contributions are immediately allocated to the individual accounts of the participants. If there are employee contributions, they may go into the same account or into a subaccount earmarked for the person. Contributions to a defined contribution plan result in eventual benefits. In a defined benefit pension plan, there is no direct relationship between contributions and benefits.
The cost-of-living adjustment feature (COLA) in a pension plan provides for increases in retirees' pensions to help keep pace with inflation. Not often found in corporate plans, a COLA is standard in federal pension plans and in many state plans and is often a feature in state or municipality pension plans for schoolteachers, police officers, and firefighters. The COLA feature may be equal to inflation as measured by a particular consumer price index or may be a percentage. A QDRO or equivalent order may include a potential COLA but does not have to. A valuation of present value for immediate offset purposes usually does not include a COLA, but it may in some jurisdictions. For example, New Jersey courts recognize a COLA in present values when the plan provides for it. See, e.g., Moore v. Moore, 553 A.2d 20 (N.J.Super.Ct. 1989).
A coverture fraction is used to determine what portion of a pension value is marital property subject to equitable distribution (usually in a defined benefit pension plan). The fraction is constructed as follows: The numerator is the period of time from the later of (1) date of marriage or (2) date of plan entry to the cutoff date in the applicable jurisdiction. The cutoff date may be the date of marital separation, the date of filing of the divorce complaint, the date of hearing or trial, or the date of the divorce decree. The denominator is the period of time from the date of plan entry to the cutoff date in the applicable jurisdiction. The ending point of the denominator should agree with the date as of which the benefit is being measured. This is also known as the time rule.
There is a cutoff date for the measurement of the values of marital property for equitable distribution, and pensions are no exception. In pensions, the cutoff date is the date as of which the accrued benefit will be determined. After that date, no benefit increases due to continuing service or increases in pay will be considered. The cutoff date varies by jurisdiction. It may be the date of marital separation, the date of filing of the complaint, the date of the divorce hearing or trial, the date of the divorce decree, or the date the plan participant retires with benefit commencement. In deferred distribution, the QDRO should clearly specify the cutoff date for benefit determination. In present value computations, it should be understood that the cutoff date refers to the benefit, not its value. That is, the benefit may be the amount of the accrued benefit as it stood five years ago, but its present value is determined by the employee's current age and using current interest rates.
A general term that encompasses all retirement and savings plans; also the name of a specific type of plan often used for key employees with an employment contract that defers payment of salary or bonus until after termination of employment.
A method of providing pension benefits in equitable distribution of marital assets. The two basic approaches are (1) the court retains jurisdiction and will award benefits of the employee-spouse to the nonemployee-spouse on an if-as-when basis and (2) a QDRO. QDROs are more common because they permit the case to be settled without further involvement of the court. Deferred distribution is in contradistinction to present value for immediate offset. In deferred distribution, it may be helpful to know the present value of the pension, but it is not required. Deferred distribution is used for a defined benefit pension plan, not usually for a defined contribution plan. A favorable aspect of deferred distribution is that both parties share the risk that the pension will ever be payable and both parties have to wait to receive any funds. The disadvantages are the administrative difficulties of drafting a QDRO and obtaining its approval, the continued linkage of ex-husband and ex-wife, and the fact that the alternate payee has to wait to receive a distribution.
1. A former employee who was a plan participant and who terminated service with vesting and is waiting to receive a pension upon attainment of a certain age has a deferred pension in the sense that it is delayed until it begins.
2. An employee who is a plan participant and who continues to work beyond normal retirement age without collecting the pension is said to have a deferred pension in that it is deferred past the age at which it was normally expected to begin.
Defined Benefit Plan
A plan designed to provide participants with a definite benefit at retirement (such as a monthly benefit of 20 percent of compensation upon reaching age 65). Contributions under the plan are determined by reference to the benefits provided for the total covered group, not on the basis of an individual's compensation.
Defined Contribution Plan
A plan with individual accounts for participants. The benefits are unknown in advance, as they are provided by the account balance when they become due and payable. Contributions from the employer and/or employee are made into the employee's account. The investment risk is borne by the employee. If investment results are poor, the account balance is low; if results from investment performance are strong, the account grows. The employer is under no obligation to guarantee investment growth. The common defined contribution plans are profit-sharing plans, Keogh plans, 401(k) plans, money-purchase plans, thrift/savings plans, and target plans. Defined contribution plans may be valued for immediate offset or may be set for deferred distribution by use of a QDRO.
In jurisdictions in which a disability pension is not marital property, it may be possible to determine that the disability pension has two components: a pension for service and compensation for the disability. Thus, if the "pure" pension portion can be split out, it can be valued and considered marital property. For deferred distribution, a QDRO may be designed to pay a portion of the nondisability component of the pension to an alternate payee.
Early retirement refers to leaving employment with a pension starting before the plan's normal retirement age. A plan may have one stated normal retirement age or several possible ages determined by a combination of age and service. Early retirement does not mean merely before age 65; it depends on the plan. Some rare plans have no early retirement provisions at all. An early retirement pension may start at a particular time even when the employee has terminated service many years earlier. For example, a plan has an early retirement provision of age 55 with 15 years of service. An employee leaves at age 50 with 17 years of service, fully vested. The retiree is a terminated vested participant with a deferred pension. When she reaches age 55, the retiree may ask for her early retirement pension to begin. In a defined benefit pension plan, the early retirement pension will be reduced to allow for its early commencement and for its longer payment period over the person's lifetime. The reduction may be calculated using actuarial factors or using a formula in the plan. If the reduction is less than computed by actuarial factors, it is known as subsidized early retirement.
Employee Retirement Income Security Act
The Employee Retirement Income Security Act of 1974 (ERISA), as amended, is the basic federal law governing all qualified retirement plans. It is designed to protect the rights of beneficiaries of employee benefit plans offered by employers, unions, and others. ERISA established the PBGC, set limits on benefits and contributions, created the title of enrolled actuary, and set forth the basic and standard conditions for qualified plans. IRAs are not covered by ERISA, but Keogh plans are covered.
Employee Stock Ownership Plan/Trust
An employee stock ownership plan/trust (ESOP/ESOT) is an ERISA defined contribution plan in which the participant's account consists primarily of the employer's stock. Valuation of an individual's interest at any particular time may be difficult because it would depend on the market value of the employer's stock at that time. Nevertheless, such plans may be valued for equitable distribution, and they are subject to a QDRO.
An IRA that is sponsored by the employer to help its employees make a tax-deductible contribution to an IRA and to invest the funds in a particular type of investment. The employer-sponsored IRA should be distinguished from a simplified employee pension plan (SEP), which requires employer contributions and must meet certain requirements with respect to participation, discrimination, withdrawals, and contributions. However, both are subject to the requirements of a QDRO, as they are considered marital assets.
The concept of marital property that attempts to allocate a fair division of the marital assets not based on community property or titled property alone. A pension that accrues during the marriage, which is neither vested nor measured, is still subject to equitable distribution.
See Employee Retirement Income Security Act of 1974.
ERISA Plan Types
ERISA divides plans into two broad categories: pension plans and welfare plans. Under the rubric of pension plan fall both pension plans and profit-sharing plans of all types. Welfare plans include medical, health, hospital, disability, and life insurance coverage plans. Pension plans are subdivided into defined benefit plans and defined contribution plans. Defined contribution plans include money-purchase pension plans, Keogh plans, target benefit plans, thrift/savings plans, profit-sharing plans, and 401(k) plans. Defined benefit plans, in addition to the traditional defined benefit pension plan, include cash-balance pension plans and defined benefit Keogh plans (the latter are rare). Defined benefit plans are distinguished in that they all require an annual certification by an enrolled actuary. Defined benefit plans may be single- or multiple-employer or multiemployer, and they may or may not be covered by the PBGC. Plans of professional corporations with fewer than 25 participants are exempt from PBGC coverage, as are plans covering only one employee or only a husband and wife.
A certified public accountant's appearance as an expert witness regarding the method of valuing a pension in a divorce case was disallowed because he had limited experience with pensions, did not understand PBGC tables, and could not explain the source of the figures he presented. His sole function was to perform the mathematical calculations, and this was considered insufficient to qualify him as an expert. Hegerfeld v. Hegerfeld, 555 N.E.2d 853 (Ind.Ct.App. 1990).
Civilian employees of the federal government are covered by one of two retirement programs, depending on the date of employment. The older program is the Civil Service Retirement System (CSRS); the newer is the Federal Employees Retirement System (FERS). Employees in service before January 1, 1983, were in CSRS and continue in it unless they voluntarily transfer to FERS. Employees hired after January 1, 1983, are in FERS. Employees in CSRS are not covered by Social Security. The CSRS pension benefit is considered generous in comparison to nongovernmental pension plans, in theory to make up in part for the absence of Social Security benefits. Participants in FERS are covered by Social Security, and the pension benefits in the defined benefit portion of FERS are relatively modest. There is a thrift plan available to FERS participants. CSRS members are in a good defined benefit pension plan and may participate in a modest thrift plan. FERS members are in a small defined benefit pension plan, may participate in a good thrift plan, and are covered by Social Security. The federal pension systems will accept a form of QDRO on the defined benefit pension plans and will accept an order on the thrift savings plan known as a retirement benefits court order.
Final Pay Plan
A defined benefit pension plan in which the benefit formula uses the pay from the last year or average of a fixed number of years before retirement. An example is the average of the highest five consecutive years' pay in the last ten years immediately preceding age 65. A final pay plan is in contrast to a career average pay plan in which 20 or 30 years of pay would be averaged in the pension benefit formula.
A plan that serves to provide a minimum benefit if a second designated plan's benefit would otherwise be smaller. For example, a profit-sharing plan may provide that if the person's account when converted to a monthly pension would be less than the pension generated by a benefit formula, then the larger pension will be paid. The underlying benefit formula would be contained in the floor plan. If the floor plan benefit is smaller than the companion plan's benefit, then the floor plan benefit is ignored. This type of plan is also known as a floor-offset plan or an offset-floor plan. It should not be confused with an offset plan, which subtracts Social Security benefits and which has nothing to do with a floor plan.
In a defined contribution plan, such as a profit-sharing plan, employees who leave without full vesting forfeit the nonvested portions of their individual accounts. These forfeitures are reallocated among the accounts of the remaining participants. However, the forfeitures may be held in a suspense account pending a formal break-in-service of the departing employee. If the employee returns to work within a specified time period, the account balance is restored. Otherwise, the forfeiture is imposed and redistributed. In a defined benefit pension plan, nonvested amounts are not specifically identified. Forfeitures of employees who leave with less than full vesting are benefits not paid, so the funds remain invested in the pool of plan assets. Remaining participants do not benefit from forfeitures in a defined benefit plan. Vested amounts in any type of plan are usually nonforfeitable with special exceptions. In a non-ERISA plan, otherwise vested benefits may be forfeited for various reasons. Forfeitures of vested benefits in an ERISA plan are quite rare.
Forms of Pension Annuity
A qualified defined benefit pension plan generally offers several forms of pension annuity to a retiring employee. In actuarial mathematics, the forms of payment are equivalent to each other, but for any particular employee one form of payment may be preferable to the others. Examples of the dollar amounts of optional forms of pension benefits are set forth below for a typical male employee retiring at age 65 with a wife age 60.
1. Straight life or life only - The retiree's pension is paid in full according to the plan's benefit formula. The pension stops when the retiree dies and there are no death or survivor benefits. The pension benefit is $1,000 per month.
2. Life with ten years certain or life with 120 monthly payments guaranteed - The retiree receives a reduced pension payable as long as he lives. If the retiree dies within the first ten years of retirement, before 120 monthly pension payments have been made, the balance of the ten years' worth of payments is paid to his beneficiary or beneficiaries. If the retiree lives more than ten years after retirement, his pension ceases at death with no further benefits due. Note that the employee may have named any number of beneficiaries or contingent beneficiaries. The pension benefit is $910 per month.
3. Ten-year certain only - The retiree's pension is increased, and the pension benefit is paid for exactly ten years. The plan guarantees 120 monthly pension payments, whether the retiree is alive or dead. Any number of beneficiaries may be named. The pension benefit is $1,200 per month, greater than the monthly straight life pension because the same value is paid out in ten years instead of being stretched out over the retiree's lifetime.
4. 100 Percent Joint-and-Survivor - The retiree's pension is reduced, based on the age of the beneficiary (survivor), a specific individual named to receive pension payments after the death of the retiree. Upon the death of the retiree, the survivor beneficiary receives the same (reduced) amount (100 percent) that the retiree was receiving. If the beneficiary dies first, there is no replacement. In some plans, a "pop-up" version allows the retiree's pension to be restored to its full amount if the beneficiary dies first. The pension benefit is $800 per month.
5. 50 Percent Joint-and-Survivor - The retiree's pension is reduced, based on the age of the beneficiary (survivor). The same conditions apply as in the 100 percent J&S annuity described above. Upon the death of the retiree, the survivor beneficiary receives one-half (50 percent) of the reduced amount that the retiree was receiving. A smaller reduction in the retiree's benefit is required because only one-half of the pension is paid to the beneficiary. The pension benefit is $850 per month.
The examples given above are illustrative only. The amounts (exact and relative to each other) will vary with the particular pension plan and with differences in the ages of the individuals, as well as with the sex of the retiree.
Section 401 of the Internal Revenue Code deals with qualified plans. This section has numerous subsections, such as 401(a), which defines the basic structure for qualified plans, and 401(k), which defines the cash and deferred salary reduction profit-sharing plans. When a plan is qualified it is known generally as a "401 plan."
General Agreement on Tariffs and Trade
The international negotiations concerning the General Agreement on Tariffs and Trade (GATT) were conducted in a series of meetings and agreements known as "rounds." In December 1994 Congress passed H.R. 5110 as Pub.L. No. 103-465 to implement the Uruguay Round. When Congress passed the Uruguay Round, the bill included pension provisions that originally had been drafted as a separate bill. These pension provisions were included in GATT, applicable to United States pension plans only, under the theory that they would produce a net revenue gain that would offset anticipated losses from GATT's trade provisions. The pension bill embedded in GATT became law under a congressional "fast track" allowing no chance for alteration.
The pension provisions are found in Title VII, Subtitle F, Part I of Subpart C, Section 767. The embedded pension provisions are labeled "The Retirement Protection Act of 1994." The mortality table prescribed therein is the 1983 Group Annuity Mortality (GAM) Table, as spelled out in Revenue Ruling 95-6.
The pension provisions in GATT prescribe the interest rates to be used in defined benefit pension plans as the smoothed average of 30-year U.S. Treasury bonds. In technical detail, that means the 30-year constant maturity rate that is interpolated from the daily yield curve, which relates the yield on a security to its time to maturity and which is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market.
The rates thus derived are reported weekly in a Federal Reserve Statistical Release known as "Selected Interest Rates," with yields shown in percent per annum. Each release lists 39 different interest rates, of which only the 30-year constant maturity rate is of concern to pension practitioners.
A plan that recognizes either benefits or contributions under Social Security. Taking into account Social Security benefits results in more benefits for the higher paid and reduced benefits for the lower paid in an allowable difference. A plan with this feature is said to be integrated or to contain a permitted disparity.
In a defined contribution plan, the interest or investment gains earned are credited to the individual account. In a defined benefit pension plan, the pension benefit is determined by a formula in the plan without regard to the investment earnings of the plan assets. To compute the present value of a pension in a defined benefit pension plan, it is necessary to use a set of interest rates to discount future potential payments to their present worth. This does not affect the benefit as a payment; it concerns its value or what it would cost to purchase an annuity. In actuarial mathematics, the present value of a future financial obligation is very sensitive to interest rates. A standard inverse relationship exists: The interest rates and the present values move in opposite directions. A lower interest rate produces a higher present value, and a higher interest rate produces a lower present value. Standard interest rate assumptions are available on a current basis, updated monthly, from the Federal Reserve Board.
Internal Revenue Code
The Internal Revenue Code (Code; IRC) covers qualified ERISA plans in Section 401(a), tax-sheltered annuities in Section 403(b), profit-sharing plans that have a salary reduction feature and are with or without matching employer contributions in Section 401(k). Section 401(k) also covers thrift and savings plans that have pretax employee contributions. All Section 401(k) plans are defined contribution plans.
Investment Gain and Loss
Individual accounts in a defined contribution plan are credited or debited with investment gains and losses usually once a year, but sometimes quarterly or even monthly. The investment results posted to the accounts include realized and unrealized performance. In other words, so-called paper gains and losses are included even though they are not actual in the absence of a transaction. When a QDRO is served on a defined contribution plan, it should indicate whether unrealized performance is to be taken into account in the award to the alternate payee.
Investment risk in a pension plan means who benefits and who loses when investments of the plan perform more or less well. Investment risk depends on the type of plan. In a defined benefit pension plan, the employer bears the investment risk. If the plan's assets perform very well, the employer may reduce its annual contributions to the plan. If the plan's investments fare poorly, the employer must make up the investment losses with larger contributions. It is not an exact dollar-for-dollar match in the year of occurrence. The enrolled actuary for the plan measures the investment gain or loss and advises the employer on contribution levels to spread out the adjustment over several years. In a defined contribution plan, the employee bears the investment risk. If the investments of a profit-sharing plan, target benefit plan, or money-purchase pension plan suffer, so does the employee's individual account.
Named for late Congressman Eugene Keogh (D-NY), Keogh plans are retirement plans for self-employed persons. Keogh plans are sometimes called "H.R. 10 plans" because Congressman Keogh's bill was the tenth bill introduced in the House of Representatives in 1962. ERISA and its amendments and other federal laws, rules, and regulations now make no distinction between Keogh plans and any other qualified plan. Most Keogh plans were profit-sharing plans, although there were a few defined benefit Keogh plans. Many Keogh plans were frozen as the laws changed, accepting no additional contributions but remaining invested as tax shelters. If a party in a divorce case has ever been self-employed or a member of a partnership, it should be determined whether there is an old Keogh plan with funds still in it. Such a plan is subject to valuation for equitable distribution and is also subject to a QDRO.
Life expectancy is both a concept and a mathematical function. In general, all defined benefit pension plans must take into account the probability of death before or after retirement. Although sometimes loosely called life expectancy, the mathematics involves the calculus of probabilities, which is not merely looking up in a table the number of years of a person's expected remaining lifetime. Published life expectancy figures are byproducts of actuarial mortality tables. For example, a standard table for white males would list the average number of years of life remaining to a white male age 40 as 34. Taken literally, this would mean the subject dies at age 74. However, the mathematical probability that a white male age 40 dies at age 74 is only 53.8 percent. That is, more than one-half of all white males who are currently age 40 will die at age 74. The rest will die either before or after they reach that age. Life expectancy is not an accurate means for developing the present value of a pension. It is an interesting mathematical concept, but it is too gross a function to be used with any precision.
A qualified ERISA plan may permit loans to participants but is not required to make loans available. If loans are available, they must be nondiscriminatory. To apply for a plan loan, a married participant must have the written consent of the spouse, witnessed by a plan representative or notarized. If a QDRO is involved, it should be made clear whether the order applies to benefits or account values net of any loans. Receipt of a loan from one's pension plan is not a taxable event unless the participant defaults on the loan or otherwise fails to repay the plan, in which case the loan will be recharacterized as a lump-sum distribution.
The failure of an attorney to protect a nonemployee-spouse's pension rights may result in a malpractice award against the attorney. In 1987, a Maryland jury awarded a wife more than $75,000 in damages against her divorce attorney. Pickett, Honlon & Berman v. Haislip, 533 A.2d 287 (Md. Ct. Spec. App. 1987). The lawyer was found negligent, in part, for failing to employ experts to evaluate the husband's assets. In 1990, the failure of a Missouri attorney to protect a wife's rights to a share of the husband's military pension resulted in a malpractice award of over $100,000. The attorney had originally advised his client correctly that a military pension was not considered marital property, but the law changed before the case was over, and the attorney was found negligent for ignorance of the new law that recharacterized military pensions as marital property.
Contributions made to a pension fund after the cutoff date for measuring marital property are the separate property of the employee-spouse, not available for equitable distribution in marital dissolution. The value of the pension at the cutoff date may be credited with passive increases, but not contributions, up to the date of trial or other settlement of the property issues in the divorce case. (Depending on the jurisdiction, the cutoff date may be the date of marital separation, the date of filing of the divorce complaint, or the date of the divorce.) In a defined benefit pension plan, the employer's contributions to the general pension fund are for all employees covered by the plan, not earmarked for individuals. The continuation or the absence of contributions in such a plan has no bearing on the employee's pension benefits. The proper value for marital property purposes is determined in a two-step process, reflecting two time frames. First, the pension benefit is determined that has accrued for pay and service up to the cutoff date. No increase in the pension benefit is counted after the cutoff date. Second, the value of that pension is determined currently by actuarial factors using the employee's current age and current interest rates. The result is the current present value of the cutoff date pension benefit.
The Armed Forces Retirement System provides generous pensions to its members who retire with 20 or more years of active duty service. There is no vesting as such, so if a member never completes 20 years' service, there will never be a pension under this system. From time to time, however, the system makes available special limited programs for retirement with fewer than 20 years of service. Military service credits may count in other pension systems to increase a pension, such as in plans for civilian employees of the federal government, certain teachers' retirement plans, or pension programs for police officers and firefighters. In a divorce, such plans will accept a form of QDRO, but the order applies only when the pension enters pay status. The retirement age in the Armed Forces Retirement System is the age at which the person retires after 20 years of service. For participants in the military reserves there is a different pension system, with retirement at age 60.
Modification of Judgment
A husband's pension was not considered in a Florida divorce case. Some years later, the wife asked for equitable distribution of the ex-husband's pension because it had been overlooked. The court chose not to reach back to modify a judgment to redistribute the assets in the divorce, including the pension. Lapinta, 13 Fla. L. Weekly 1969 (1988). However, a 1990 case in West Virginia allowed the decree of final judgment to be reopened because the parties had misunderstood the value of the pension. The schoolteacher husband had received a statement from the retirement system stating the amount he would receive if he left employment at that time. Later, he realized that the stated amount represented only the return on his contributions and that the actuarial pension value was much greater. The court allowed the mistake to be corrected. Langdon v. Langdon, 391 S.E.2d 627 (W.Va. 1990).
Money-Purchase Pension Plan
A defined contribution plan under which the employer's contributions are mandatory and are based on each participant's compensation. Retirement benefits under the plan are based on the amount in the participant's individual account at retirement.
The probability of mortality is a vital element in the computation of the present value of a pension. In pricing an annuity, the probability of the death of the annuitant at any future time must be included in the calculations. Several standard mortality tables, which fall into two broad categories, are available for use. Within a particular category there is not much significant variation unless it is a very old table - say, 50 years old. However, the categories are important. There are mortality tables for life insurance that are dramatically different from pension or annuity mortality tables. Mortality rates in life insurance tables are higher because they anticipate more deaths. In annuity or pension tables, mortality rates are lower because they anticipate fewer deaths and longer lives with more payouts. This structure allows for variations among the covered population and has proved to be a financially stable arrangement over many years.
Need for Attorney
In a 1990 California case, the parties to the divorce agreed on property distribution without the knowledge of their respective attorneys. As part of their agreement, each party would keep his/her own pension plan. At trial three years later, the attorneys first learned of the agreement. There was no evidence of the value of the pension plans and no proof that the wife's pension was equal to the husband's. The court decided that whenever a party is represented by counsel, a stipulation or agreement affecting the party should not be accepted without the knowledge and consent of the attorney. In re Marriage of Maricle, 269 Cal.Rptr. 204 (Cal.App. Dist. 1990).
In determining the present value of a pension in pay status, it is important to distinguish between the net and the gross pension. The gross pension is the amount of the payment the retiree is entitled to receive from the pension plan. The net pension is the actual amount of each pension check after deductions. The deductions may be mandatory or voluntary. They may include union dues, health insurance premiums, life insurance premiums, withheld taxes, charitable contributions, and other miscellaneous items. Deductions from the gross pension may include loan amounts being repaid, missed employee contributions being made up, and purchase of prior service credits. For valuation purposes, it is usually appropriate to focus on the amount of the gross pension, although taxation may be taken into account in some venues. In deferred distribution by use of a QDRO, it is essential for the order to clearly specify whether the net or gross pension is involved.
Every plan establishes benefits on the basis of a "normal form." In a defined contribution plan, it is to be expected that the normal form will be a lump-sum distribution. In a defined benefit pension plan, it is usually a straight lifetime annuity, ceasing at the death of the retiree. A typical plan will offer, at retirement, options to convert the normal form into some other form. The conversion may be determined as the actuarial equivalent of the normal form, or it may be somewhat better than the mathematical adjustment so that the pension is subsidized. A defined benefit pension plan covered by ERISA must provide for a qualified joint-and-survivor annuity (QJSA) if the participant is married. However, a QJSA need not be the normal form, because it may be reduced by the plan to adjust for the coverage of two lives. The normal form is one of the determinants of the present value of a pension. If a QDRO is served on the plan, the form of pension should be addressed.
Normal Retirement Age
The normal retirement age (NRA) in a plan is the age that, when attained, permits the participant to voluntarily cease employment and receive a full, unreduced benefit, whether a lump-sum distribution or an annuity. NRA is also the measuring point for vesting. For example, if a participant has not attained full vesting under the plan's vesting schedule for years of service, upon reaching NRA, full vesting becomes automatic. The NRA may be a fixed age (such as 65) or may be derived from a formula or from a combination of age and service. Some examples are (1) age 60 with 10 years of service, (2) age 55 with 20 years of service, (3) any age with 35 years of service, (4) a "magic number" (such as 85) consisting of the total of the employee's age (58) and years of service (27 years).
A plan that reduces participants' benefits by an amount specified (by formula) in the plan. A defined benefit pension plan may dovetail its benefits with Social Security by subtracting a percentage of the Social Security benefit from the plan's formula benefit. This is a method of integrating the plan with Social Security, using the IRS rules for permitted disparity. The concept of permitted disparity allows for higher-paid employees to receive larger benefits than lower-paid employees by recognizing the curve over which Social Security benefits are constructed.
Offsets to Pension
A plan may provide that pension benefits are decreased or offset by disability benefits, unemployment compensation, or worker's compensation. In valuing a spouse's plan benefits for equitable distribution or for deferred distribution, these possibilities should be considered. If offsets exist in the plan, then the individual facts and circumstances should be considered to see if these items are applicable. In some cases, if a retiree returns to work for the same employer or in the same industry, his or her pension may be reduced or suspended. If there is any possibility of such reduction or suspension, it should be examined in detail.
When an employee retires and starts receiving monthly pension payments, he or she is said to be in pay status. (In rare cases, a plan participant may be in pay status while still employed.) Such payments have a present value, actuarially determined as the present worth of the future stream of expected payments taking into account mortality and interest. If a retiree in pay status is divorcing and a QDRO is served on the plan, the QDRO may order a portion of the retiree's pension benefits be paid to the alternate payee. Usually, a QDRO is thought of as a form of deferred distribution, but a pension in pay status is immediate, not deferred, and it may be subject to a QDRO-ordered division of the amounts being paid. Whether pension payments should be counted as income for purposes of measuring alimony is an issue to be settled by the facts and circumstances of the particular case.
See Pension Benefit Guaranty Corporation.
Pension Benefit Guaranty Corporation
The Pension Benefit Guaranty Corporation (PBGC) is a federal government corporation chartered under ERISA to insure certain defined benefit pension plans. A plan covered by the PBGC files annual returns and pays a premium required by federal law and regulations. If such a plan should terminate with insufficient assets to provide promised pension benefits, the PBGC will take over the plan and pay the pensions, up to stated maximum amounts.
Pension Valuation Formula
The formula for computing the present value of a person's benefits in a defined benefit pension plan is: Benefit X Rate X Fraction. "Benefit" is the individual's accrued benefit under the plan, based on pay and service and any other plan features up to the cutoff date in the applicable jurisdiction, stated as a monthly pension payable at normal retirement age. "Rate" is the GATT rate at the time of the valuation, using the person's current age and the normal retirement age. "Fraction" denotes the portion of the present value that is marital property, and it is calculated by dividing the years of service while married and in the plan by the total years of plan service to the cutoff date. During and following 2004, "rate" is the interest on the average of major corporate bonds.
Most legal jurisdictions accept a spouse's interest in a pension plan as marital property for equitable distribution in divorce. When the pension plan is a defined contribution plan with individual accounts (e.g., a 401(k) plan, a thrift or savings plan), a participant's pension is equal to the amount in his or her account.
Defined benefit pension plans pose more of a conceptual problem because the promised pension benefit is usually due many years in the future, when the employee retires. The actuarial answer is that the appropriate present value does indeed equal the worth of the pension, whether it is a future pension to be paid or a pension now being received. The only difference is that there is a discount period for the active employee to represent the chance of death before retirement while also discounting the future prospective pension for interest during the period before payments begin. A pension of any kind always has a calculable value. In some cases, the court may wish to modify the pure actuarial result by increasing or decreasing the present value based on the particular facts and circumstances of the case. The starting point should always be the pension value mathematically computed using standard methods and reasonable actuarial assumptions of mortality and interest.
The actuarial answer often seems frustratingly unsatisfactory to the family practice lawyer who knows that if the client - the employee - dies before retirement, then there is no pension. Nonetheless, the divorce settlement may award the pension's present value to the nonemployee-spouse.
The actuary has included in the computations of present value the probability of death either before or after retirement, but the actuarial assumptions are not predictions. The employee-spouse may die the day after the present value of his pension has been distributed in a divorce settlement. Alternatively, he may live a long time. No one can say, but an actuary can provide a value that takes potential longevity into account.
A period certain is a form of pension sometimes offered by a defined benefit pension plan as an option at retirement. This form of pension pays the retiree a fixed monthly amount for an exact period of time, regardless of when the retiree dies. For example, assume a period certain pension of $1,000 per month will be paid for exactly ten years. If the retiree continues to live beyond the ten-year period, there is no further pension, as it was payable only for ten years. If the retiree dies before receiving ten years' worth of pension payments, the balance is payable to the retiree's beneficiaries or estate. There is, by contrast, the certain and life pension, a form of pension that continues to be paid beyond the original guaranteed time period as long as the pensioner lives.
A title created by ERISA for qualified plans. Every ERISA plan must designate a plan administrator in the plan document and in the summary plan description. The plan administrator may be an individual, a committee, or the employer entity. Generally, the plan administrator is not the consulting, administrative, or actuarial firm that provides services for the plan, nor is it the trustees that hold plan assets, unless specifically named as such. The plan administrator is responsible for operating the plan, making decisions concerning eligibility, vesting, benefits, and all other details. It is the plan administrator who reviews a DRO and decides if it is a QDRO.
Plans are often amended to keep up with changing laws and regulations, or as a result of a change in the employer's circumstances. A plan amendment would not reduce participants' accrued benefits, but it may well increase them. An amendment may increase future benefits only or may have a retroactive effect increasing all benefits, past and future. An amendment may change the future terms and conditions of benefits, such as the normal form or early retirement age. The possibility of a future plan amendment is ignored in the computation of present value; however, in deferred distribution using a QDRO, the parties should consider whether or not to include potential future changes in the plan.
A summary plan description (SPD) is often in the form of a booklet, so it is commonly referred to as the plan booklet. However, there is no required size, shape, or form of printing; thus, even if an SPD is called a booklet, it may not appear to be one.
The formal plan text of an employer-sponsored qualified retirement plan. This is the binding legal contract under which a plan is established and maintained. A copy must be available for inspection by a participant at no cost. A reasonable charge may be imposed for a participant to keep a copy.
Every pension plan runs on an accounting year or fiscal year, known as the plan year, which is any 12-consecutive-month period that has been chosen by the plan for keeping its records. Common plan years are the calendar year, January 1 to December 31, and the June 30 year, July 1 to June 30. However, a plan may use whatever 12-month period was selected when the plan was established; for example, March 1 to the last day of February, or October 31 to October 30, or April 1 to March 31. If the plan routinely issues benefit or account statements, they will be determined as of the last day of the plan year and may be expected to be available from three to six months after the plan year has ended. All of the forms for governmental reporting will be based on the plan year. If the plan does not routinely issue benefit or account statements and one is being requested for property valuation in divorce, it is usually administratively more convenient for the plan to provide benefit or account information as of a plan year-end date rather than some specific date that may be the date of marital separation or divorce complaint. This is also true for QDRO purposes.
An employee working beyond normal retirement age in a defined benefit pension plan is on postponed retirement, also known as deferred retirement. Some plans may allow the pension to start at normal retirement age even though the participant is still employed. If so, the pension is in pay status and not postponed. If the pension is postponed, the plan must increase benefits in one or both of the following ways: (1) Pension benefit accruals increase as pay and service continues, or (2) the pension benefit may no longer grow with pay and service but will be increased by actuarial factors to recognize its postponement. The most generous plan will increase the late pension for continuing pay and service and by actuarial factors.
Present Value Update
The current worth of a pension is as of a given date (the valuation date). All pensions have present value, whether the pension is vested, deferred, matured, or in pay status to a retiree. In a divorce case, some time may pass between the time the valuation was made and the date the case is ready to be adjudicated. Sometimes, months or even years will go by until the case is heard. Counsel for the divorcing couple may attempt to bring the pension value up to date by adding interest to the previously determined pension value. Updating the pension's present value, however, creates problems for the following reasons:
1. The present value of the pension was initially determined using mortality and interest discounts. The participant is still alive, so the mortality decrement would have to be factored back into the value.
2. Interest rates change over time. The interest rate that might be used to update a prior value may well lead to controversy over what rate is appropriate and reasonable.
3. The pension plan may have been amended, the employee-spouse's status may have changed (active, terminated, disabled, retired), and changes in statute and/or case law that would affect current results may have occurred.
The proper way to update an existing valuation is to perform a new, current valuation.
In a defined benefit pension plan, the plan formula is used to estimate the future pension benefit of a participant. Using current pay information, assuming that the person continues to work until normal retirement age and that pay remains level, the ultimate pension benefit may be calculated. The future benefit can be projected taking into account future pay increases. This projected benefit is an estimate, not guaranteed, because the plan may be amended before the participant retires or the participant may terminate service with the employer. The projected benefit may be illustrated in a benefit statement to the employee. Sometimes only the projected benefit is shown, not the accrued benefit. In computing present value, care should be taken as to the benefit being used. In deferred distribution, it should not be assumed automatically that a projected benefit will be exactly what is currently estimated.
An ERISA plan that has met the federal statutory and regulatory requirements, has received a favorable determination letter from the IRS, and maintains its qualified status by amendments to comply with changes in laws and regulations as they occur from time to time. Every qualified plan is an ERISA plan, but not vice versa, as it is possible for an ERISA plan to lose its qualification. Being qualified ensures the tax-sheltered status of the plan's investments and defers taxation of plan participants on accruing benefits and/or account values until these are actually paid out.
Railroad Retirement System
A non-ERISA plan managed by the Railroad Retirement Board (RRB). Railroad workers' pensions consist of two parts, known as "tiers." Tier I is equivalent to Social Security, is not included in valuations of marital property for equitable distribution in divorce, and is not subject to attachment by QDRO. Tier II, however, is a regular type of defined benefit pension plan; it is subject to valuation and attachment as if it were an ERISA plan.
When a party in a divorce action is retired and receiving pension payments, the data required for the pension valuation is somewhat different from what is needed in the case of an active employee. In addition to name, date of birth, and so forth, the following information is needed:
1. Date of retirement and the last day worked
2. Date of commencement of pension payments
3. Type of retirement with respect to timing (Normal, Early, Special Early, Late, Deferred)
4. Form of pension (straight life, fixed number of years certain, life with a guaranteed payment period, joint-and-survivor (percentage), or a combination of more than one form)
5. Whether the pension is a fixed, level amount or subject to change at a certain future date or upon attainment of a stated future age
6. Whether the pension is subject to cost-of-living increases
7. The gross amount of the pension
8. The net amount received
9. The named beneficiary(ies) if there are any post-retirement death benefits
For purposes of a pension plan or profit-sharing plan, a participant may "retire" yet remain in active employment. If the plan so provides, a participant who reaches the plan's retirement (e.g., age 65) may start receiving benefits whether or not he or she ceases to work. Therefore, a participant may work beyond retirement age and receive both a salary and a pension. Termination of employment without commencement of pension payments may be loosely called "retirement," but it is not considered retirement in the pension sense. The concept of retirement is usually reserved for those cases in which pension payments are made either as a lump sum or as an annuity in pay status.
Retirement Equity Act
The Retirement Equity Act of 1984 (REA), as amended. The REA established the concept of and the requirements for a QDRO.
When some time has passed after a valuation of a defined benefit pension plan in a divorce case, a new valuation may need to be done. Whether to do a revised valuation depends on how much time has passed and how much interest rates have changed, if any. If the person's age has changed by one year or more, the present value will change. If interest rates have changed by more than one-half of a percentage point, revision of valuation would be warranted. However, an increase in interest rates resulting in a decrease in present value may offset the increase in present value due to increased age. In actuarial present value, values are inverse to interest rates: the higher the rate, the lower the present value. Another consideration is case law. If there has been a significant change in local case law that would affect the results, the valuation should be revised.
For purposes of estimating employer contributions that fund a defined benefit pension plan, an actuary will often use a salary scale table to project future pay increases for the covered group of plan participants. Some employers may show estimated future pension benefits with illustrated future pay increases in annual benefit statements to participants. There are three general methods used in salary projections:
1. Use a fixed annual interest rate to calculate the average annual pay increase for future years (e.g., 3 percent or 5 percent per year).
2. Use salary scale tables that have been developed by actuaries. There are 15 to 20 such tables available.
3. Develop the pay history from the experience of the covered group for a particular employer or by industry.
Salary projections are generally not used for valuations of pensions in divorce except in New Jersey, where family courts allow their use.
The cutoff date in some jurisdictions for measuring marital property, also known as the marital separation date. The separation date has significance in the valuation of pensions in two respects: (1) The monthly pension benefit accrued for service and pay may be valued up to the separation date, and (2) the separation date may be used in the denominator of the marital coverture fraction to measure the marital portion of the pension benefit or value.
Note that spouses sharing a house may be legally separated. The date that one spouse moved out of the bedroom into a separate bedroom on a different floor of the house may mark the separation date. Living in separate areas of the same house, not socializing, not eating meals together, and virtually not speaking to each other constitutes living separated and apart.
Retirement plans measure an employee's length of service in three ways:
1. Continuous service represents the actual length of employment.
2. Credited service represents the period of time during which the employee is earning pension credits.
3. Vesting service is the period of time that is counted in the plan's vesting schedule to obtain partial or full nonforfeiture rights to a benefit. Each service may have its own definition in the plan, when it starts, when it ends, how absences are counted, conditions of minimum and maximum time periods, and so on.
Some plans offer this option, also known as buy-back, which allows an employee who terminated service and was subsequently reemployed to recoup prior service credits. A service purchase provision may also be found in governmental pension plans for obtaining credit for military service.
There are conflicting opinions on whether severance pay should be considered marital property. Two cases in California dealt with whether a spouse's employment severance benefits are community property when they are received when the marriage is ending. The rulings in both cases affirmed that severance payments are not community property, because, unlike pensions, they are made in lieu of future service, not as a reward for past service and not as deferred wages. In re Marriage of De Shurley, 207 Cal.App.3d 992 (1989); In re Marriage of Lawson, 208 Cal.App.3d 446 (1989). However, in Arkansas, a nonemployee-spouse was awarded one-half of the employee-spouse's severance pay when the court decided that the benefit was earned by years of service during the marriage. Dillard v. Dillard, 772 S.W.2d 355 (Ark.Ct.App. 1989).
Social Security Benefits
Social Security benefits are not subject to equitable distribution, so present values are not computed and a QDRO cannot be used. A court may, if it wishes, recognize that a person will or will not receive Social Security benefits for purposes of measuring income. In occupations not covered by Social Security, there may be a generous defined benefit pension plan that presumably makes up for the absence of Social Security benefits. In such a case, it is possible to compute a theoretical Social Security pension and then subtract its present value from the actual pension present value to arrive at a net value for the basis of equitable distribution. It is also possible to make such an adjustment in deferred distribution.
Social Security Integration
Social Security benefits and taxes are structured upon a wage base established by federal law. The wage base changes from time to time, generally increasing every year by a cost-of-living measure. An individual whose annual income exceeds the wage base in a particular year pays taxes and eventually will receive a benefit conditioned only on the wage base. The pay in excess of the base is not counted for Social Security. An individual whose pay is always below the wage base receives benefits based on entire pay. This disparity leads to an allowance for a pension plan to provide higher benefits in a formula using pay above the wage base. A plan is said to be integrated with Social Security when it recognizes Social Security either in terms of benefits or the taxable wage base, which results in more benefits for the higher-paid participants and less for the lower-paid participants. This differential is known as a permitted disparity. Another approach is to subtract from the pension formula benefit a percentage of the Social Security benefit. In all cases, Social Security itself is not affected. The person receives the Social Security benefits to which he or she is entitled. It is the pension plan that works around Social Security.
Social Security Offset
A defined benefit pension plan may be integrated with Social Security in that the plan benefit formula subtracts a percentage of a computed Social Security benefit. Social Security itself is not affected, only the pension from the plan is modified. Some individuals are not covered by Social Security by virtue of their employment. For example, civilian employees of the federal government in the Civil Service Retirement System are not in Social Security. In most of these cases, and in the Civil Service especially, the employer provides a pension benefit that is larger than would be available in comparable jobs. The theory is that the pension benefit subsumes Social Security. If this reasoning is followed, then in valuing such a pension as marital property a theoretical value representing imputed Social Security would be subtracted out of the pension value. Cornbleth v. Cornbleth, 580 A.2d 369 ( Pa. Super. 1990).
Social Security Retirement Age
The age at which an individual may apply for and receive full, unreduced Social Security benefits, known as the primary insurance amount (PIA), depends on the individual's year of birth according to the following table:
Born 1937 or earlier
Born 1955 or later
Stipulation of Value
In the interest of saving time and expense, and with the perception that pension values are difficult to ascertain and to understand, the parties to a divorce may stipulate the equitable distribution of pension values. Before the stipulation is made, however, counsel for the spouse whose pension is at issue should obtain a reasonable estimate of the pension value. Occasionally, circumstances are such that the court will reject a stipulation. A change in pension value after the stipulation may or may not be considered depending on the situation. If a stipulation is a reasonable compromise, it may be accepted even though it is not as precisely accurate as possible. In re Marriage of Hahn, 273 Cal.Rptr. 516, 517 (Cal.Ct.App. 1990);
In re Marriage of Norris, 302 Or. 123, 727 P.2d 113 (1986);
Wayda v. Wayda, 576 A.2d 1060 (Pa.Super. 1990); Negrotti v. Negrotti, 98 N.J. 428, 487 A.2d 328 (1985).
Summary Plan Description
Every qualified ERISA plan is required to have a summary plan description (SPD) that summarizes the terms and conditions of the plan in language designed to be understood by the typical plan participant. Because it is usually printed in the format of a booklet, the SPD has come to be known as the plan booklet even if it is not in the size or shape of a booklet. The plan administrator must keep a supply of SPDs available and must give one to every employee, whether or not the employee is a plan participant (with certain exceptions for nonunion members). Note that the SPD is not the same as the governing plan document. The plan document must be made available for inspection at no cost at the main office of the plan administrator, and a reasonable fee may be charged for making a copy for a plan participant.
A defined contribution plan with individual accounts that is also known as a target benefit plan or an assumed benefit plan. The plan contains a benefit formula that sets forth the theoretical retirement pension. The employer makes actuarially determined contributions to fund the targeted pension. The employee will not receive that pension, however. The employee receives the balance in his or her account. The individual account consists of employer contributions and investment gains and sometimes employee contributions. A target plan is subject to valuation for equitable distribution and to a QDRO. If a QDRO is served on the plan, it should award a percentage of the account rather than a lump-sum amount or a monthly pension.
Pension payouts are taxed first to the recipient as personal ordinary income in the year in which received. If paid as an annuity, the total amount received each year is subject to personal ordinary income tax. If paid in a lump sum, the pension may be eligible to be rolled over into an IRA to defer taxes. Annuity payments are not permitted to be rolled over. If there have been employee contributions, the taxable portion of the received benefits is adjusted. Payments to a former spouse (alternate payee) pursuant to a QDRO are taxable to the recipient, not to the participant. If a lump sum is paid by the QDRO, it is not subject to the premature distribution 10 percent excise tax penalty, regardless of the age of the alternate payee. This is true whether or not the lump sum is rolled over into an IRA.
The Teachers Insurance Annuity Association and College Retirement Equities Fund is a special kind of insurance company for the use of Section 501(3)(c) institutions such as universities, colleges, teaching hospitals, and museums. It receives contributions, holds and invests the monies, and then makes annuity payments to retired employees. TIAA-CREF is a voluntary program on two levels: The employer has the option of participating, and each eligible employee of a participating employer has the option of joining. TIAA-CREF itself is not a pension plan; it is a funding vehicle. It will accept the equivalent of a QDRO upon proper processing and set up a separate account for the divorced spouse. The TIAA portion of a participant's account is invested in fixed-income investments, whereas the CREF portion is in equity securities like a mutual fund. Each participant has the choice of allocating his or her account among TIAA and CREF in varying percentages. TIAA-CREF accounts are subject to valuation as well as to deferred distribution.
Used to determine what portion of a pension value is marital property subject to equitable distribution by use of a fraction (usually in a defined benefit pension plan). The numerator of the fraction is the period of time from the later of (a) date of marriage or (b) date of plan entry to the cutoff date in the applicable jurisdiction. The cutoff date may be the date of marital separation, the date of filing of the divorce complaint, the date of hearing or trial, or the date of the divorce decree. The denominator is the period of time from the date of plan entry to the cutoff date in the applicable jurisdiction. The ending point of the denominator should agree with the date as of which the benefit is being measured.
An ERISA plan in which either the benefits or contributions are weighted more for higher-paid employees than for lower-paid employees, within permissible limits. When a plan is considered top-heavy, it is required to have faster vesting than a plan that is not top-heavy. The status of being top-heavy may vary from year to year. In general, a plan is top-heavy if more than 60 percent of the benefits or contributions are attributable to key employees. In a top-heavy plan, there are minimum requirements for benefits and/or contributions for the non-key employees.
There are two entirely different meanings to this phrase: (1) The use of the present value of the pension as an immediate offset compared to other marital property in equitable distribution may be considered to be a total offset of the pension, and (2) the computation of the present value of a pension discounts future amounts to the present by taking interest and mortality into account. If it is supposed that the future rate of inflation is exactly equal to the interest rate, then it could be argued that they offset each other in a total offset. This concept is rarely used in valuation of pensions in divorce.
A method of attempting to identify marital property in the assets of a pension plan, usually a defined contribution plan. Every contribution made by the employer and by the employee is accounted for, with the separate investment results attributed to each activity. This is a very difficult and time consuming process that is rarely used.
A union member is a person who belongs to a union in connection with his employment with an employer who has a collective bargaining agreement with the union. The person would be covered by a multiemployer pension plan. If the person is an officer or office staff employee of the union and the union has its own pension plan, the person would be a participant in two plans: the multiemployer plan and the union's own plan. If the person is a high-level union official he or she may also be an officer or employee of the national union and a participant in the union's national pension plan and, therefore, a simultaneous participant in three pension plans.
Unit Benefit Plan
A defined benefit pension plan in which the benefit formula is based on a small unit multiplied by the number of years of credited service. The unit may be a dollar amount or a percentage of pay. An example would be $25 of monthly pension per year of service, so that with 30 years the pension is $750 a month. Or, the formula could be one percent of pay per year of service (pay having its own definition, varying by plan), so that with 30 years of service and average monthly pay of $2,000 the pension is $600 a month.
If the present value of an individual's pension in a defined benefit pension plan was computed more than one year before the case is due to be heard or settled, the present value must be updated. It is not correct to merely add interest to the prior value, because the old value was computed using the interest rates of a year ago. Because interest rates generally change over time, the value would have to be recomputed as of the prior date using current interest rates before it can serve as a basis for updating. Furthermore, the old value was computed using a mortality discount, and the person is still alive; so the mortality component would have to be added back. The preferred method for updating is to do a new, current valuation based on current age and current interest rates.
To determine the present value of a defined benefit pension plan for immediate offset for equitable distribution, it is necessary to have a specific valuation date. The "present" in present value refers to the valuation date. On a given valuation date, the person's age, length of service, and eligibility for benefits will be determined. The valuation date also will determine what assumptions the actuary makes as to mortality tables and interest rates. Some jurisdictions require that the valuation date be as close as possible to the date the divorce is settled, the date of distribution. In this context, distribution does not mean that the pension plan makes a payment, but rather that the marital property is distributed.
Vesting and Vesting Schedules
Vesting bestows on an employee a nonforfeitable right to a pension. All ERISA plans must contain an approved vesting schedule by which a plan participant attains the rights to a pension. There are standard schedules from which a plan may choose and one required schedule if the plan is top-heavy. Union plans, known as multiemployer plans, have a different set of rules. A plan may have a vesting schedule that is more generous, but not one that is more strict. Some non-ERISA plans have no vesting as such, in that an employee must qualify for retirement to receive a benefit; termination of service at a time the employee is not eligible for a pension results in loss of all benefits. The Armed Forces Retirement System, for example, has no vesting prior to retirement eligibility.
Retired military personnel receive a pension if they are eligible. This is called a military or armed forces pension or a veteran's pension. If it is a regular pension for service, then it is treated routinely in a divorce case. The pension has a present value, and it may be the subject of a court order equivalent in effect to a QDRO. A medical or disability pension is different. In most jurisdictions, a disability pension will not be included as marital property. The exact description and details of any such pension should be obtained.
Year of Service
The concept of year of service, introduced by ERISA, is important in the determination of a participant's accrued benefit account balance at any time. A plan may define a year to be a consecutive period of 12 months in which the participant has attained at least 1,000 hours of service, or it may define a year as the period between the first day and the last day of the particular plan year. When the measure of a year is the completion of 1,000 hours of service, the employee will receive credit for a year of vesting and benefit accrual about halfway through a particular year. Attention should be paid to the timing if a person otherwise appears to be about six months short of attaining eligibility, vesting, or benefit accrual.
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