What happens to a state pension in divorce?
What happens to a state pension in divorce?
You’re devastated that your marriage didn’t work. And the thought of the financial upheaval that will result from your divorce is difficult to digest. What will your finances look like after divorce? What about at retirement?
If either you or your spouse has a MA State Pension, it’s typically one of the more valuable assets in divorce, and how it will be divided can have a significant impact on both parties.
First, under MA divorce law, all assets owned by either party are subject to division. How they’re divided depends on a number of factors, including the length of the marriage, the parties’ financial circumstances, their capacity to earn income going forward, their contributions to the marriage (economic and non-economic), other assets to be divided, and other factors.
First, it’s important to understand the difference between a pension and a 401k, 403(b) and other similar plans.
What type of retirement account is it? There are essentially two types of retirement plans: direct benefit plans and direct contribution plans.
A direct contribution plan is one in which employers, employees, or both make regular contributions to the plan, and the value of the plan is based on how much money goes into the account(s) and how the investments perform over time. An example of this is a 401k or 403(b).
The other type of retirement plan is a direct benefit plan, otherwise known as a pension. In a pension, the employer promises the employee a specific payment, usually monthly at retirement, but it can also be a lump sum. The amount of payment is determined by a formal based on the employee’s earnings history, length of employment for the company, age at retirement, and other factors. Examples of pensions include a Massachusetts State Retirement Pension and Union/Laborer Pensions.
What’s the key difference between these types of retirement accounts? The main difference is that the pension is essentially a promised monthly payment upon retirement whereas 401ks and 403(bs) contain an ascertainable amount of money in an account that hopefully grows over time.
One of the difficulties in dividing retirement assets in divorce is that you generally cannot determine the actual present cash value of a pension by looking at a statement. You may see an annuity amount, which is typically the amount contributed by the employee to the plan. But that doesn’t reflect the actual value of the pension. Confusing the annuity amount with the overall pension value is a common and costly mistake.
On the other hand, when you look at a 401k or 403(b) statement, it’s easy to determine the balance: it’s typically the largest number listed on the statement.
The significance is that it’s difficult to compare the value of a pension to other assets without a pension appraisal. If you want to offset an interest in a pension with that of a 401k, equity in a house, or any other asset, it’s important that you hire a qualified pension appraiser. It typically costs between $450 - $650 for an appraisal. This may be a good investment as it will identify the actual present cash value, which will better help you reliably compare the value of the assets.
How is a pension divided after divorce? Once the parties or the judge determines who gets what from which retirement account, the accounts are divided. This is typically done by a Qualified Domestic Relations Order (QDRO - pronounced “qua-dro”). A QDRO is a document approved by the court that instructs the plan administrator on exactly how the account should be divided pursuant to divorce.
Typically, the marital portion of a pension—what was accrued while the parties were married—is divided between them. Division is especially likely in longer marriages.
The QDRO is typically drafted by a specialist, it’s then approved by the court, and finally submitted to the entity or administrator for implementation. Once the participant retires, the percentage of the marital portion of the pension that was set aside for the ex-spouse is payed out—usually monthly.
Now that we understand how the pension is divided and paid out, let’s move on to the morbid issue of what happens when the participant dies.
What happens to pension payments if the participant dies? The issue of what happens to the pension payments upon the participant’s death—whether before or after the start of pension payments—is addressed in the survivor benefits designations.
Here are the different options:
Pre-Retirement Survivor Benefits Pre-retirement survivor benefits address what happens when the participant dies before starting to collect any pension payments. The parties may elect to award the pre-retirement benefit to the former spouse or not. This designation doesn’t affect the pension payout. In other words, there’s no real cost to choosing a pre-retirement survivor benefit. The only issue is whether the participant chooses the ex-spouse or someone else (children, siblings).
Although this issue is negotiable, the preretirement benefit is usually awarded to the former spouse in long-term marriages.
How are pre-retirement benefits affected if either party remarries?
If the ex-spouse is chosen as beneficiary and remarries, that person becomes ineligible to receive the benefit as a survivor annuity, but would be eligible to get the benefit in the form of a refund of contribution. However, this must be specified in the QDRO. If on the other hand the participant remarries, and has been remarried for at least a year at the time of death, the new spouse can claim the survivor annuity, and that would trump any QDRO assigning the former spouse benefits.
Post-Retirement Survivor Benefits Once the pension payouts begin, the rules are different. There are three options for post-retirement survivor benefits.
-Option A: This offers no protection the the ex-spouse. It pays out 100% of monthly benefit until the participant’s death. There’s no deduction from the monthly payout. But when the participant dies, there are no further payouts to anyone.
-Option B: This offers limited protection to the ex-spouse if designated as beneficiary. It pays out 97-99% of the monthly benefit amount. But when the participant dies, the beneficiary receives a refund of unexpended member contributions in a lump sum. This can be split among several beneficiaries. However, in most cases, after about 10-12 years of pension payments, there isn’t anything left to pay to beneficiaries.
-Option C: This offers the most protection for the ex-spouse. It pays out only about 85-93% of the monthly benefit for the participant’s lifetime. However, upon the participant’s death, the former spouse gets a monthly payment for life equal to two-thirds of the total, reduced benefit being paid. The amount of this payment is based on the entire pension benefit at retirement, not just the marital portion. The 7-15% reduction is the “cost” of Option C, and is deducted from the total payment made each month. The parties can allocate the costs—how much of the cost each pays—by agreement or the judge can make that decision.
If the ex-spouse dies after the participant’s retirement, there’s no further reduction for Option C and the amount of the life annuity assigned to the former spouse goes back to the participant.
This article provides an overview of how state pensions are handled in divorce. However, because these are typically one of the more valuable assets in divorce, it’s advisable to talk to a divorce lawyer about your rights on this issue before entering into any agreements on this issue—especially if you’re considering offsetting assets for division.
If you have any questions about how state pensions are handled in divorce or any other family law questions, feel free to contact us.