Anything But My Pension: Divorce Math
In a previous post, I discussed how divorcing couples divide financial assets and debts during divorce mediation. In it I provided an example of how the decision to share 401Ks, IRAs, and similar retirement savings funds is handled.
In this post, I’d like to help you understand how a defined benefit pension is handled as part of the asset distribution during a divorce.
What Is a Defined Benefit Pension Plan?
It is a company pension plan in which an employer promises to pay the retiree a specified monthly benefit on retirement for the rest of his or her life. The monthly benefit amount is predetermined by a formula based on the employee’s earnings history, length of service, and age.
Today, very few companies provide a traditional defined benefit pension to employees. However, virtually all city, county, state, and federal employees are currently eligible for a defined benefit pension.
Anything But My Pension
There is something about a defined benefit pension that is very emotional. Perhaps it is because, for the most part, people who receive such pensions provide have challenging careers, such as firefighters, police, teachers, mail carriers, and military personnel. In many cases, a pension is a symbol of very hard, sometimes dangerous, and stressful work.
When a couple is ending a marriage, financial security is a huge worry, and it is often downright scary. With so many variables regarding the future, a defined benefit pension represents a safety net because it promises a guaranteed income for life. Sharing that safety net with your ex-spouse, often many years in the unpredictable future, can feel scary and unfair.
Facts and Myths about Defined Benefit Pensions
Myth: My spouse will receive 50% of my pension.
Fact: Your spouse may be eligible for part of the marital portion of your pension. You and your spouse come to agreement on how to divide the marital pension. I explain this below.
Myth: Why should my spouse get any part of my pension after we are divorced?
Fact: Your pension is like a savings account that was accumulated during your marriage. So, that portion of your pension is just like any other marital asset.
Myth: I am the one who worked at this job all these years with the crazy hours and dangerous situations. Why should I share the benefit?
Fact: The concept is that, during your marriage, your spouse partnered with you in order for you to work the stressful and difficult hours. Perhaps he or she managed the home front and did most of the child-rearing. Your spouse certainly spent time being worried about you while on the job and hoping you would come home safe and sound.
Myth: My pension has to be shared, right?
Fact: No. Your pension, like any other asset, is part of a larger conversation of asset and debt distribution in your divorce. In mediation, clients make informed decisions and may trade-off one asset for another. A spouse may say “no, thank you” to the pension, for lots of reasons.
Myth: What if the pension does not exist in the future? What happens?
Fact: Then both parties share the risk of the loss, and neither party will receive anything from the pension.
Understanding New York State Distribution of Defined Benefit Pensions in a Divorce
As mentioned above, a defined benefit pension is shared in a manner quite different from an IRA, 401K, 403B, etc. In NY State, the Majauskas Formula is used as a standard for determining how defined benefit pensions are to be shared after divorce, should the couple decide to do so.
The Majauskas formula (as defined by the NYS Comptroller) defines the marital portion of a spouse’s pension as a percentage of the full pension earned by that spouse. To calculate that percentage for one spouse’s pension:
- Y = Years of pension service credit spouse accrued DURING the marriage.
- T = Total years of pension service credit spouse accrued at retirement.
- Y/T = Marital portion of the pension.
The formula ONLY defines the marital portion that is eligible to be split between the spouses.
Then the couple decides whether they want to divide the marital portion between them, and if so, how. They can split it 50/50 or in any other way they agree upon.
Majauskas Formula Example of Sharing a Defined Benefit Pension
Let’s go through the example of Bob and Sally. Here are the assumptions:
- They were married for 12 years.
- Sally was a teacher for all of those 12 years.
- The pension rules set by Sally’s employer say her pension will be 60% of her final salary.
- Sally decides to retire after 30 years of working as a teacher.
- Sally’s final salary at retirement is $80,000.
- Therefore, her annual pension will be $48,000 (60% of $80,000).
- Bob and Sally decide to split the marital portion of her pension 50/50.
Here is how the martial portion is calculated for Bob and Sally based on the above assumptions and using the Majauskas Formula:
- The marital portion of Sally’s pension is the number of years Sally worked as a teacher during the marriage (12) divided by the total years Sally worked (30). So the marital portion percentage is 12/30, or 40%.
- Sally’s full pension is $48,000. Multiply $48,000 by 40% to get the marital portion, $19,200.
- Since they decided on a 50/50 split, Bob is then eligible to receive half of the $19,200, or $9,600, annually for the rest of Sally’s life.
- Sally will receive $38,400 annually ($48,000 minus $9,600, Bob’s share) for the rest of her life.
If Sally works for only 20 years, the marital portion will be higher: 12/20 = 60%. But the dollar value of the marital portion is likely to be smaller because she did not work 30 years, thus being eligible only for an amount less than the full retirement benefit.
Benefits of the Majauskas Formula
- Because the actual calculation is completed at the time Sally retires, there is no guesswork about the value of the pension. That means actual numbers will be used instead of estimates or guesses.
- Bob will receive his portion of the marital portion directly from New York State. A separate court document is prepared after the divorce that instructs NY to do the distribution. That form is called a Qualified Domestic Relations Order and referred to as a QDRO (pronounced “kwa-dro”).
- Bob has the option to reduce his share of the marital portion by a certain amount to insure that he will receive his share of the marital portion over the course of the rest of his life versus the rest of Sally’s life. This is referred to as a survivor benefit within the pension plan.
Trading the Pension for Another Asset
Sometimes clients will say: “Sally can keep her pension, and I will keep the house.” This means at the time of the divorce, Bob would not pay Sally her half of the equity in the marital house. That may seem like a fair trade.
However, to truly understand what is being traded, the future dollar value of the pension must be converted to today’s dollars. Then that value needs to be figured into the overall picture of the couple’s assets and debts to be divided.
Not only that, you never know what might happen to a pension. There are plenty of cases where promised pensions have been lost due to under-funding of pension investments, company bankruptcies, and other situations. It is wise to be cautious about trading off today’s assets for a future asset.
How does the trade-off of a house for a future pension work?
How might this trade work in Bob and Sally’s example? If Sally retires at 60 and lives to 85 (an insurance actuarial estimate), that is 25 years. Let’s use Sally’s annual pension from the earlier example, $48,000. Bob’s share of the marital portion of that was calculated to be $9,600.
So if Bob shares her pension, he would receive $9,600 annually for 25 years (Sally’s life expectancy). That comes to $9,600 x 25 years or $240,000.
The next step is to figure out how much the estimated future total annuity, $240,000 would be worth in today’s money (present value).
Calculating the Value of an Asset
Therefore, the question to answer is: What would you have to invest today to have it grow to be $240,000 over the next 30 years?
To resolve this, Bob and Sally should use the help of an appropriate financial professional to work through the math. Important questions to be answered are what interest rate will be used to calculate growth of an investment and how long will Sally actually work. Those assumptions can make a big difference.
By going through these steps, whatever they decide, Bob and Sally will have confidence that they were well-informed and made a decision that works for them.
Difficult But Necessary Conversations
Discussing money and finances and security are complicated and hard conversations in the best of times. Throw in emotional upheaval and the heartache of ending a marriage, and it seems beyond challenging.
As a mediator, I guide clients to separate the emotional and the financial worries in order for each of those themes to be heard and valued. I find that when space is created for both conversations, clients are often reassured and sometimes even surprised at the outcome.
It is always hard to separate assets. In truth, both parties end up with less than what they had together, and it is hard to feel safe and OK. Adjusting to a new financial and emotional situation takes courage and acceptance and a willingness to let go of the struggle.
There is an expression that may provide some perspective: “A person feels rich when what they want is what they have.”
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