While divorce can very often be a contentious event, there are times when the separation is amicable. However, even when both parties agree on how assets should be divided, it is still possible that misunderstandings or innocent mistakes can lead to hardship down the road. This is an example of a “we agree, but we don’t understand what we agree on” situation, and one particular scenario in which this can happen is the splitting of a pension plan.
When most people envision a divorce settlement, the investment assets that come to mind are 401(k)’s, IRA’s, or Brokerage Accounts. The division of these assets are typically straightforward, because it involves the question of “How much of the account am I comfortable receiving/giving up?”.
However, the division of a pension tends to be more of a question of “How (to whom) and when will the division occur?”. Since this question often involves multiple options, even well-intentioned individuals may find themselves making an ill-advised choice. One option of utmost importance in any pension scenario is whether the QDRO (Qualified Domestic Relations Order) is drafted to create a “Shared Payment” or a “Separate Interest.”
Shared Payment
The Shared Payment method (sometimes called the Shared Interest method) can be thought of as a “Who?” type of QDRO question since the primary function is only to determine who will receive benefits from the plan. The “How?” part of the plan (timing and calculation of benefit payments) doesn’t change; everything continues to revolve around the pension plan participant. For example, a shared payment method may allow for the alternate payee to receive 50% of all benefits paid by the plan. However, the plan participant can still select the form of benefit to be paid (life annuity, joint and survivor annuity, lump-sum, etc.). As a result, the “shared” election only truly takes place once benefits begin.
This can present a problem, as the alternate payee is at the mercy of the plan participant as to when benefits will begin and how long they will last. Since the plan participant can select the form of benefit, there is the risk that the participant chooses a form of benefit that does not continue after their death. For these reasons, it may be wise to weigh another option in some pension cases (Note: In “grey divorce” cases where pension benefits have already begun, the Shared Payment Method is the only available option).
Separate Interest
As long as payments from the pension plan have not already begun, the pension can be split using the Separate Interest method. This approach takes the current plan balance and divides it into two separate accounts, one for the participant and one for the alternate payee. The alternate payee’s account is adjusted to reflect their life expectancy, effectively turning them into an additional participant. Future decisions by each party have no impact on the other’s separate account. The Separate Interest method can be beneficial in many cases because it answers the “Who?” question in addition to the “How?” question. While not all divorce cases may be eligible for this method of division, it can be a handy tool in certain instances.
Each divorce case is unique and carries its own set of ramifications and nuances. When a pension is involved, it can create additional complexity and add even more questions to the equation. Neither of these options is a perfect solution for all cases. However, it is essential to understand how your clients may benefit from a properly constructed pension division. Please feel free to contact us with any questions regarding this matter, as well as any other financial issues that may occur throughout the divorce process.
-Josh VanFleteren, MBA AAMS
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Investment advice offered through Strauss Financial Group, Inc., a Registered Investment Advisor.
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