Legal Guide

Dividing Retirement Assets Incident to a Divorce

by: Brian G. Paul, Esq.

Besides the marital residence, pensions or retirement accounts are normally the most valuable asset accumulated during the course of a marriage. Notwithstanding that fact, the division of retirement assets incident to a divorce remains the greatest source for confusion, and one of the leading causes for malpractice claims arising from divorces. It is therefore imperative that individuals with retirement assets utilize the services of an attorney with substantial matrimonial experience in order to ensure that their rights are properly protected when these valuable assets are divided.

Retirement assets provided through an individual's employment normally come in one of two forms-- defined contribution plans or defined benefit plans. In defined contribution plans, such as 401 (k) accounts, the individual defers a portion of their income into an account within the company's retirement plan which has been opened especially for that specific individual. The defined contribution account then grows tax deferred with the individual paying taxes at the time the money is actually withdrawn. In contrast, a defined benefit plan promises that upon retiring the employee will receive a defined amount of monthly income for the duration of the employee's lifetime. The monthly benefit that the individual receives will normally be based upon a specific formula, which can be found in the plan documents, and usually places an emphasis on the years of service with the company and the salary at the time of his retirement.

Depending upon the type of retirement asset, they are normally distributed in one of three ways at the time of divorce. Under the first option, which is commonly referred to as the "immediate" or "present value offset" method, an immediate distribution buyout occurs utilizing the present value of the pension or retirement account, and then trading other property against the retirement assets' present value. Accurately determining the present value of the retirement asset is obviously quite important when utilizing the present value offset method. Defined contribution plans, such as 401(k) accounts, and Individual Retirement Accounts are distributed via the present value offset method, inasmuch as their present value is easily obtainable and dividable. In cases where money must be transferred from a defined contribution account in order to accomplish the present value offset, a Qualified Domestic Relations Order (QDRO) may be necessary. In contrast, IRAs can be rolled over from one account to another without the need of a QDRO. Because retirement assets are often tax deferred, it is important to determine whether the asset against which the retirement account is being offset, is comprised of pre-tax or after-tax dollars. If one asset is in after-tax dollars while the other asset represents pre-tax dollars, an adjustment must be made in order for the two assets to be fairly and equitably offset against one another.

In cases involving a defined benefit pension in which the employee receives a monthly payment at the time of retirement based upon the plan's formula, a pension appraiser must be utilized in order to calculate the pension's present value if the parties wish to distribute the asset via the immediate offset method. The appraiser performs the calculation by adjusting the anticipated sum of the pension payments for the life expectancy of the employee, the inflation rate, and a discount factor which represents the ability of the money to earn interest over time. After the present value is calculated, the present value is then offset against other assets just as an IRA or 401(k) account would be. Again, it is imperative that the value of the assets be adjusted in order to ensure that they are all being considered in the same form-- either in pre-tax or after-tax dollars. It should also be noted that virtually all defined benefit plans prohibit an individual from withdrawing monies from the plan until they actually retire. Accordingly, in cases involving a defined benefit pension where there are insufficient assets against which to effectuate an immediate offset, an alternate method must be employed.

The second option for dividing retirement assets, the "deferred distribution method", refers to payments made to the non-employee spouse from the pensioner's pension payments at the time the pension monies are actually received after retirement. This is the most commonly utilized method of equitably dividing a defined benefit pension as in most cases the marital estate does not contain enough assets in order to effectuate an immediate present value offset. When utilizing the deferred distribution method to divide retirement assets, the court and the parties must be careful to ensure that the amount of payment received by the non-employed spouse is fair, and not discounted to the value of past dollars. Obviously, the present value of a dollar differs from its value at some time in the future or some time in the past. Therefore, one must be careful to ensure that future benefits are not paid in present dollars without a discount and present benefits are not discounted to the value of past dollars.

In a long line of cases, New Jersey courts have set forth a formula, known as a "coverture fraction", in order to ensure that the rights of both parties are fairly protected when the deferred distribution method is utilized. The purpose of the coverture fraction is to limit the non-employee's share of the pension to the portion earned during the course of the marriage, while at the same time permitting it to grow in size as a result of outside factors such as interest income. The numerator of this fraction represents the period of time that the employee participated in the pension plan during the marriage (from the Date of Marriage to the Date the Marriage Ended), while the denominator represents the total period of time that the individual participated in the plan at the time of retirement (Total Number of Years of Service). The coverture fraction is then multiplied against the percentage of the pension awarded to the non-employee spouse and the monthly pension payment actually received. The deferred distribution method normally requires the use of a QDRO, in order to assure that the Plan pays the non-employee spouse their share of the pension payments when the pension goes into pay status.

The final method that may be employed is a hybrid of the immediate offset and deferred distribution method. In cases where there are some assets available for a partial immediate offset, but not enough to totally effectuate a full present value buyout, the two methods can be employed in tandem. Under such a scenario, the non-employee spouse would receive a portion of the present value of the pension in the form of other assets, with the remaining portion being paid at the time of retirement in accordance with the deferred distribution method. Accordingly, this method is useful in situations where there are not enough liquid assets available to immediately effectuate equitable distribution.

Szaferman, Lakind, Blumstein, & Blader, P.C.
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