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Basic Pension Principles
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Tax Treatment in Pension Evaluation
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Offset Plan: 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.

Pay Status: 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.

PBGC: 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.

Pension Worth: 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.

Period Certain: 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.

Plan Administrator: 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.

Plan Amendment: 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.

Plan Booklet

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.

Plan Document: 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.

Plan Year: 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.

Postponed Retirement: 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.

Projected Benefit: 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.

Qualified Plan: 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.

Retiree Data: 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

Retirement: 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.

Revised Valuation: 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.

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