What to Know about Your Retirement Plan

In separation and divorce, division of retirement accounts may seem daunting; there are two varieties that we, as a divorce attorneys, encounter regularly: defined contribution plans and defined benefit plans. Defined contribution plans are the ones where you contribute money into an account, often with pretax payroll deductions. Your 401k, 457b, and Thrift Savings Plans are defined contribution plans. Defined benefit plans are generally based on investments over time and are formulaic in nature. To put it more simply, these are pensions.

Defined Contribution Plans

With defined contribution plans, in the context of separation and divorce, you focus on the money contributed plus gains and losses. There are tracing considerations to keep in mind when you have premarital or post-separation contributions. When we refer to “tracing considerations” we recognize that spouses often work before they get married and contribute to their defined contribution plans, and, as a result, they are entitled to keep those contributions and the earnings on those contributions without having to share with their soon-to-be ex-spouse.

North Carolina law states that premarital and post-separation contributions are a spouse’s separate property. Thus, it’s necessary to trace the contributions made during the applicable periods and determine what the gains are for that separate pre or post-separation amount versus the gains on contributions made during the marriage in order to properly divide the asset.

As family law attorneys, an issue we often face arises when spouses don’t keep the statements for their defined contributions plans they get in the mail. Generally speaking, there are no set standards requiring plan administrators to maintain records, and the possibility exists that prior records are lost or destroyed with the passage of time and/or changes in the plan administrator. It happens more often than you may think, and when it does, if you are trying to claim that a part of your account is separate property, you may have an evidentiary problem. If you don’t have those statements, it can be really difficult to trace your separate property. In North Carolina, the burden is on the party asserting that an asset is separate property to prove it, so you want to ensure you get the necessary statements or consult with your attorney or CPA about alternative ways to determine your premarital contributions.

If the defined contribution plan is your spouse’s, you need the statements to not only determine your marital interest, but also to examine whether he or she withdrew amounts before you separated, took out loans, and/or made transfers of the asset to other accounts that you might be unaware of. You must account for this and determine why it was done. Did your spouse take out a loan on their 401(k) during the marriage, which in North Carolina would be considered a “marital” debt, but then use the money for a “separate” property purpose? Your attorney will help you get to the bottom of it and make sure you receive what you are entitled to equitably receive.

Be careful when your spouse suggests that they will “equalize” money owed to you from their defined contribution plans. Say they owe you $25,000 for past-due child support and tell you they will have their attorney prepare a Qualified Domestic Relations Order (QDRO) or Domestic Relations Order (DRO) to transfer $25K to you.

What is the problem? Well, although the transfer of the asset to you will likely be tax-free, 401(k) withdrawals are not tax-free. If you attempt to access the money, you will pay taxes, and, potentially, penalties depending on when you make the withdrawal. Your attorney and CPA can help you strategize a little bit to minimize taxes, but you are going to have to account for that aspect, and you likely will not actually receive the full amount of money you are owed.

It is very common for the defined benefit and defined contribution plans accumulated during the marriage to be the marriage’s most valuable assets; a great deal of care needs to be taken when considering them as part of your marital estate.

Defined Benefit Plans

Defined benefit plans differ from defined contribution plans in that benefits are typically based on a number of factors including, but not limited to, the following: your age, your years/hours/points of service, and/or your final or highest average compensation. Every plan has a different formula and required numbers of years of service (or points, if you are in the military).

You might be tempted to look at your or your spouse’s most recent statement for a defined benefit plan and conclude that the balance shown on the statement is what the asset is worth. If the statement does not show a “lump sum” amount for the benefit then you would be mistaken. The balance on the statement is typically not the actual present value of the asset, but rather the amount the participant has contributed during their employment/service plus some interest. It does not typically reflect the employer contribution.

If you want to find out what a pension is worth, you will need an actuary do an analysis based upon life expectancy and present-day discounting (especially if you want to attempt to cash out your share of your spouse’s benefit). Actuaries calculate the lump sum values of streams of payment, which is what a pension benefit really is.

If you are not considering cashing out, or if that option is not available, there are TWO types of interest you can receive from your spouse’s defined benefit plan and both will require a Domestic Relations Order (DRO).

Separate Interest DRO

With a separate interest DRO, the non-participant spouse’s interest is segregated into its own pension and it is adjusted to their own life expectancy. They are then eligible to be paid for their life (although depending on their actual age, the alternate payee spouse may receive less each month than the participant). Your payout is determined by your life expectancy. If the alternate payee spouse dies before the participant spouse, the benefit will not “spring back” to the participant spouse.

Shared Interest DRO

With a shared interest DRO, the alternate payee spouse’s benefit is tied to the participant spouse’s benefit. Thus, you will not begin receiving a benefit until the participant spouse retires, and payments will end when the participant spouse dies (unless a joint-survivor annuity is elected). If the alternate payee spouse dies, the benefit may “spring back” to the participant spouse. If the participant spouse has already begun receiving their pension benefit prior to separation/divorce, then the shared interest approach is most likely the only available option.

It is very common for the defined benefit and defined contribution plans accumulated during the marriage to be the marriage’s most valuable assets, and a great deal of care needs to be taken when considering them as part of your marital estate.