Does it matter if my spouse’s retirement is a defined benefit or a defined contribution plan?
Yes. This matters when it comes to calculating the value of the plan. Equitable distribution is a four step process – First property and liabilities are identified, then they are classified as marital, separate, or divisible. Next, property must be valued – the fair market value as of the date of separation is the applicable value to assign any asset or liability. Finally, the property must be distributed.
A defined contribution plan is a plan designed so that the employer, employee or both make contributions on a regular basis. For instance, a plan setup so that each pay-period a percentage of an employee’s paycheck is deposited into a 401(k), and the employer matches a certain percentage of contributions, is a defined contribution plan. A defined benefit plan, on the other hand, is a type of pension plan in which an employer agrees to pay a specified monthly benefit upon retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service and age. The two plan types are very different, and understandably the way you value the plans is different.
For a defined contribution plan, there is a simple math equation, known as the coverture fraction, that helps determine how much of the plan is marital. You would divide the length of time a spouse was simultaneously married and contributing to the pension plan by the total length of employment during which the pension was earned.
A defined benefit plan is harder to value. For these plans, the amount paid at retirement is typically based on the salary of the employee’s last years of work. So if a couple is separating and the spouse with the defined benefit plan is only 35, how can you place a value on what the plan is really worth? In these situations, the courts will apply a five-step process to determine the value of a defined benefit plan:
- Determine the earliest date that the spouse can retire.
- Determine the life expectancy at the date of separation to determine how many months the employee-spouse will get the benefits.
- Determine the value of the pension at the earliest retirement date.
- Discount the value to the date of separation (figure out the future value and discount that value to the date of separation).
- Determine any contingencies that may occur and discount the value further.