Divorce And Understanding Retirement Benefits

By Staff Writer

Retirement benefits are generally considered "marital property" and, as such, subject to distribution during a divorce. In such situations, even if you did not earn the retirement benefit, you may be entitled to share in the retirement benefits of your estranged spouse. If this is the case, understanding the type of retirement benefits to which you may be entitled will enable you to make financial and other plans for your future and assist you in structuring an appropriate divorce settlement with your former spouse.

Retirement benefits fall into one of two categories; defined benefit plans or defined contribution plans. It is important to realize the many employers offer more than one type of benefit plan. It is crucial that, before entering into a settlement or going to trial, you determine precisely how many of these accounts that your spouse has with his current and former employers. After you have determined the number of accounts to which you may be entitled, you should determine whether the account is a defined benefit plan or a defined contribution plan.

Defined benefit plans are those which an employees does not pay for, or to which he or she does not make financial contributions. Rather, it is a benefit of employment which the employer provides to its employees. The most common example of a defined benefit plan is a pension. The value of the pension cannot be determined simply by looking at a monthly statement but rather, is usually calculated based upon a plan formula that takes into consideration the employee’s salary before retirement and years of service. Defined benefit plans will rarely make payments prior to retirement or lump sum payouts. Rather, benefits typically commence upon retirement and are paid in regular monthly intervals.

In valuing defined benefit plans, it is also important to determine when the employee will be vested in the plan. If an employee is not vested in a defined benefit plan and is terminated or ceases employment, he or she will forfeit the right to collect plan benefits. Only after an employee has worked for a certain period of time (typically five years), will the employee be guaranteed plan benefits upon retirement. This does not mean, however, that if you are divorcing prior to the time at which your spouse will be vested in her defined benefit plan, the plan is not marital property. Generally, if a divorce is finalized prior to vesting, the plan is still considered marital property. The fact that the employee-spouse has not yet vested in the plan, however, will be considered in determining the value of the plan and its distribution to the parties in the event that the employee spouse becomes vested.

Defined contribution plans make up the second major category of retirement benefits. For these types of plans, the employee makes contributions to the value of the account (such as by salary deferrals or other type of regular payments to the account). The employer will usually also make contributions to the plan depending upon the amount of money contributed by the employee. Examples of defined contribution plans are profit sharing plans, ESOP and 401k accounts.

Vesting is rarely a concern in determining the value of defined contribution plans. An employee is always 100% vested in the money which the employee has contributed. It is necessary, however, to review the plan rules to determine when the employee will be vested in any money contributed to the plan by the employer.

Unlike defined benefit plans, it is not usually necessary to wait until retirement to begin collecting benefits. Many plans allow loans and withdrawals from the plan. Because such distributions typically have tax consequences, it is important to speak with an accountant prior to taking any money from the plan. During divorce, plans will usually allow the parties to segregate the portion of the plan being received by the non-employee spouse. A separate account is usually established by the plan to hold the funds awarded to the non-employee spouse or a "trustee to trustee rollover" is allowed.

A trustee to trustee roll-over allows the non-employee spouse to establish or designate a separate account into which he would like his portion of the defined benefit plan deposited. After necessary plan forms are prepared and submitted, the defined benefit plan will send the designated amount of money directly to the plan administrator of the account designated by the non-employee spouse. Provided that the money is transferred directly between the two plans, there will be no tax consequences to the non-employee spouse. If, however, the money is withdrawn by the non-employee spouse or is sent directly to him, that party will be subject to the normal tax consequences associated with early withdrawals from the account.