Retirement plan interests are often one of the most valuable assets, other than real estate, that most couples will have to allocate during a divorce. Chapter Four in Divorce Strategy explains the different types of retirement assets and describes how they can be handled during a divorce. An outline of the subsections in the chapter follows. Then, there is an excerpt from the chapter.
Subheadings for Chapter Four: Retirement
Nest Egg or Broken Egg?
Individual Retirement Accounts
Keogh and SEP Plans
Deferred Compensation Plans
Employer Sponsored Retirement Plans
Types of Plans
Identifying Your Retirement Plan
Qualified Domestic Relations Orders
Pension Benefit Guaranty Corporation
Specialized Retirement Plans
Accessing Retirement Funds Now
Preparing for Your Retirement
Excerpt from Chapter Four: Retirement
Nest Egg or Broken Egg?
There are many different types of retirement plans from small, self-directed individual accounts to very large group plans managed by professionals. A self-directed account in an individual retirement account (IRA) or an annuity can be funded by the owner who contributes money directly to the investment. An IRA is often used as a rollover account for a distribution from a company 401(k) or other retirement plan. The larger group plans can be public, private, specialized or government sponsored retirement plans. These plans can be funded by the employee, the employer or both. How these factors, and others, affect the division of retirement assets in a divorce is explained in the following sections.
In some employer sponsored plans, a person can contribute money directly into his or her account, an employer can then match or pay more than the employee contribution. In other plans, only the employer can contribute money. Each plan is unique and has guidelines and restrictions about dividing the account after a divorce.
For purposes of the divorce court order, the Participant is the spouse who earned the benefit and the Alternate Payee is the ex-spouse of the Participant. The Surviving Spouse may be an ex-spouse or the present spouse of a Participant. If your divorce involves the division of a retirement plan or account, be sure to check on the requirements of the division with each Plan Administrator or account custodian. Then plan your division to comply with the requirements for each type of account.
Individual Retirement Accounts
Individual Retirement Accounts (IRA’s), are divisible by a court order. Before the account division, the custodian of the account will require a certified copy of the court order. Also, the receiving spouse will have to complete the proper elections or payout forms. The funds in the IRA are paid directly to the receiving spouse or rolled over into an IRA in the name of the receiving spouse. If the receiving spouse elects to receive money instead of rolling it into an IRA, taxes and penalties may be owed.
An annuity is a savings plan sponsored by an insurance company. You can purchase it through a life insurance broker, financial planner, securities broker and some mutual funds. The earnings in the annuity are tax-deferred. The contribution is also tax-deferred if the annuity is part of an individual retirement account.
The key elements of an annuity contract in a divorce are the owner, the annuitant, the beneficiary and how benefits are paid. Usually, one person is the owner of the annuity; however, in some types both spouses can be owners. The annuity pays earnings based upon the projected life span of only one person, the annuitant. The owner has the right to designate the beneficiary of the annuity in the event of the annuitant’s death. Finally, the payments from an annuity can be in a lump sum paid at a certain preset time or periodically over a number of years. All of these terms play a part in how you would decide to divide an annuity.
The company that issued the annuity contract determines what is divided and how that division occurs. Typically, the issuer of the annuity requires that specific language be used in the settlement agreement or court order. In some cases, the issuer will even require a separate court order similar to a Qualified Domestic Relations Order. This order must follow criteria established by the issuer and the issuer must approve and accept the order before it divides the annuity.
Types of Plans
In general, there are two types of pension plans: defined contribution and defined benefit. A defined contribution plan is one in which the value of the plan is determined in part by the amount of contributions made into the plan. The employee, employer or both can make contributions to the retirement account.
The valuation of a defined contribution plan is relatively simple. It can be determined by multiplying the account balance by the percentage of vesting. The amount of the contributions is usually preset as a percentage of gross income of the individual or as a share of profit in the case of a profit sharing plan. The employer may also, at its discretion, make additional contributions if the plan permits. The employer is responsible for depositing the contributions into the retirement plan at certain times during the year. These times are usually described in the plan’s summary documents and may be monthly, quarterly, semiannually or annually.
A defined benefit plan is one in which the Participant is eligible to receive a specific, periodic payment beginning at retirement. In some plans, the Participant can elect to receive this payment in one of several ways. The chosen method can affect the amount or timing of the payments. Be sure to check the plan’s rules regarding distributions or benefit payments. In a defined benefit plan, the employer makes contributions to a retirement account on behalf of the employee and the employee becomes vested in his or her account after a certain number of years of service.
You can value this plan in one of two ways. First, an actuary or accountant can mathematically compute the present-day value of the future income stream from the plan. Second, rather than using a present-day cash value, you can divide the future income stream by a Domestic Relations Order. The present-day cash value of the retirement benefit may be a substantial amount, especially for an employee who has participated in the plan for a long period of time. A divorcing spouse may benefit from using this valuation method as a tactic to encourage the other spouse to trade an interest in the pension for a different asset.
Some states and some judges will not value a defined benefit plan by the present-day cash value method. In these instances, the court may choose to divide the pension account by a Domestic Relations Order rather than award the pension to the participating spouse.