Category: Offsetting Assets

Danger of Offsetting Pension and 401(k) Plans

Danger of Offsetting Pension and 401(k) Plans

Defined Benefit (DB) Pension and Defined Contribution (DC) 401(k) plans have very different characteristics, including valuation methods, funding and investment risks, and distribution options.  Even retirement plans of the same type very rarely have the exact same features and risks.

To illustrate this let’s assume a divorcing couple, Tom and Nancy, are both age 45. Tom has worked 25 years and has a pension benefit of $2,200 per month at age 65, the present value of which is $245,000.  Nancy has a 401(k) balance of $245,000.  Each party wants to keep his/her own plan in exchange for his/her share in the other party’s plan.  After all, both assets have the same value.  However, before counseling your client about this matter, consider the following:

Pension Valuation Risks

Calculating the present value of a pension benefit is complicated and takes into account several actuarial factors. However, the present value may not include a benefit enhancer that vests after divorce, like an early retirement subsidy, but that is based largely on marital service.

In our example, let’s further assume Tom’s plan has an early retirement subsidy that allows him to retire with full benefits after 30 years of service.  In this case, the value of Tom’s pension just 5 years in the future, at age 50, is about $600,000.  Nancy would have to achieve an almost 20% rate of return over those 5 years for her 401(k) to be worth a similar amount.

Pension Funding and Investment Risks

Generally, a pension plan sponsor cannot reduce a person’s previously earned benefits, and must sufficiently fund the plan to make promised benefit payments.  As a result, the plan sponsor typically assumes both the funding and investment risks.  However, if the sponsor does not have the assets to fund the plan, or if the plan’s investments underperform, a participant may not receive all the benefits he/she earned.  Although the PBGC guarantees most private employer pensions against bankruptcy, its guarantee has limits.  Union plans, many of which are severely underfunded, may be able to reduce previously accrued benefits.  Also, several state governments are considering cutting pension benefits to deal with budget shortfalls.

401(k) Funding and Investment Risks

Whereas a pension promises a certain amount of benefits at retirement, a person’s 401(k) benefit at retirement depends entirely on the amount he/she contributes to the plan (plus employer contributions, if applicable) and investment performance.  As a result, although a 401(k) account balance may be equal to the present value of pension benefits at divorce, that balance may be materially less or greater than the pension value at retirement.

Equally Sharing the Risks/Rewards

There may be legitimate reasons to offset retirement assets; however, the only way to accurately equalize the parties’ retirement assets, including sharing risks and other plan features, is to divide each plan with a QDRO.

Issues with Offsetting a Pension Decision

Issues with Offsetting a Pension Decision

Ganues v. Ganues, 3rd Dist. Seneca No. 13-18-36, 2019-Ohio-1285 (Decided April 8, 2019).

Issue: Can Husband terminate spousal support for Wife, which he agreed to pay for life in lieu of splitting his military pension, after suffering a significant decrease in income and after the Wife has remarried?

Decision: The Third District Court of Appeals affirmed the trial court’s decision that Husband could not terminate his spousal support obligations. The Husband and Wife were married for almost 30 years. During that time, the Husband served in the military and, after 20 years of service, retired and received his benefits of approximately $20,000 per year. When the parties divorced, the Husband agreed to pay the Wife spousal support until one of them died in exchange for retaining 100% of his military retirement benefits. Six years after the divorce, and after the Husband had a significant decrease in his wages, Husband was over $18,000 in arrears on his spousal support. The Wife was remarried at the time, so Husband sought to have his spousal support obligations terminated. The trial court denied the Husband’s motion to terminate because the parties agreed Wife would receive spousal support for life in exchange for her interest in the military pension, which is a lifetime benefit. However, the Wife was merciful to the Husband and agreed to have his spousal support lowered to $10,000 per year—which represented her share of his military pension.

Observation: This case represents just one of the perils that can arise when trying to offset assets/support payments to avoid dividing a pension. At the time of divorce, the Husband clearly did not want to divide his military pension and believed it was a good idea to pay spousal support instead. However, as he learned the hard way, life circumstances and incomes can change. Instead of simply dividing the military pension, the Husband found himself in arrears and had to pay additional court costs/legal fees just to end up dividing the pension several years later.

How we can help: Our services go beyond just drafting QDROs, we act as advisors to our attorney clients. We can provide you with our expertise, gained over decades on concentrating solely on dividing retirement benefits, to help you formulate the best strategy for your clients. With the proper advice in the beginning of the case, we can help you draft the correct separation language and draft a correct QDRO that will secure the benefit your client gained through negotiations. We can help you with the burden of the technical; arduous; and to the unsuspecting novice, perilous issues of dividing retirement accounts so you can concentrate on custody, child support, and the other litany of immediate issues faced in a divorce.