Our firm is often approached by parties and counsel to determine the present value of a future pension. The goal being to assign an exact dollar amount to a future payout in order to offset an asset currently held in the marital estate. Red flags immediately are raised as Illinois is an “equitable division” state and offsets are by definition more agreeable to one party.
“Pension” is sometimes a term that is used to describe many different kinds of retirement assets today and occasionally is a catchall for all retirement instruments including defined contribution plans (like 401k’s, 403b’s, 457’s or any self-managed investment portion of a retirement fund, an IRA or brokerage account distribution, annuities (whether in pay status or not), and traditional defined benefit plans. This blog will address the traditional defined benefit plan contributed to through employer contributions which guarantees retirement benefits for employees based on a set formula that considers an employees’ salary, age, and tenure with the company. Pension Plans are payable upon the participant’s retirement when the Fund will determine and calculate the final amounts payable on a monthly basis for the life of the participant and sometimes for the life of an alternate payee, if that additional feature has been elected.
When we are asked to value this stream of income for a party or their counsel, the goal in the divorce negotiations is often to balance this future income stream against a larger current asset when other liquid assets are not available to “buy out” the marital property for example, or to balance against their ex-spouse’s future income stream, so each party can just keep control over their individual pensions.
This can be the proper approach in some instances, but the parties should understand the inherent risks of assigning an exact dollar amount to an asset that typically will not pay out for a number of years, and more importantly, is dependent on a multitude of factors that the parties cannot control. Pensions are dependent on so many factors, it is near impossible to put an actual dollar value to such an asset, especially a specific value for a specific matter.
So, what are some of these risks? There are many variables, including how long the participate will work, when they will elect to retire, the extent of their salary increases until their retirement and how long they will collect the pension until their death (i.e. their individual risk for sickness, death and the company’s viability and profitability.) Since a pension is an if, as and when type of asset and due to all these variables, assigning a value today to buyout an asset with a known present value can put both parties at risk.
Illinois state pensions that require a QILDRO to assign the assets in a divorce, like TRS, SURS, SERS, City of Chicago, County of Cook, and police and firefighter pensions (not 457 plans), will end on the life of the participant and do not take the life of the alternate payee into consideration. So while actuarial tables can predict the average life span of the participant, they cannot predict the actual life span of the ex-spouse.
The date of retirement in corporate-sponsored defined benefit pensions can often be made null by drafting a separate interest QDRO and the parties will not be reliant upon the retirement date of their ex-spouse to begin collecting the pension, nor will they need to consider the life expectancy of their ex- since elections can typically be selected to run on the alternate payee’s lifetime. However, an annuity over the sunset years of an alternate payee provides a different kind of benefit than a cash in hand today exchange for a current marital asset.
Determining the future value of an annuity stream can be somewhat more precise the closer a participant is to retirement and especially if they are already in pay status. However, there are a wide variety of factors than lend themselves to assumptions in the valuation of a defined benefit pension which include the final pay of the participant (as pensions often use the highest years to determine the payments), the life expectancy of the participant (sometimes), the life expectancy of the alternate payee (in every case), the length of service and employment of the participant, the health of the pension fund, and the rate used to calculate the present value of the stream of payments over the lifetimes.
While we generally advise that parties “ride-along” for the pension benefits and alternate payees be assigned the marital portion of any pension earned during the marriage in their Marital Settlement Agreement due to the wide ranging factors listed above and the risks of either assigning too little or too much in exchange for a current asset or even against an ex’s defined benefit pension, there may be some cases where this is the proper approach as long as the parties and counsel understand these risks and that the potential actual payouts could vary greatly from the assignment in their Marital Settlement Agreement.
Our office can provide some scenarios for your review if you are considering this approach and we can provide referrals to trusted actuaries for a more detailed present value analysis. Please contact our office to schedule a consultation by phone 847-926-7679 or online at our website anneschmidtlaw.com.
Cheri McIntyre, Managing Director
Anne Prenner Schmidt, Esq.