Calculating the Present Value of a Pension for Division of Marital Property
by
Julia Rueschemeyer on Dec. 14, 2020
Divorce & Family Law Divorce & Family Law Divorce
Summary: There are two ways of dividing a pension in divorce. The future stream of payments can be shared or the pension participant can "buy out" the spouse at the time of divorce and keep 100% of the future payments. In order to "buy out" a spouse, you must calculate an actuarial present value of the pension.
There are generally two types of retirement accounts: 401k-type accounts ("defined contribution") and traditional pensions ("defined benefit"). Traditional pensions are common among school teachers, firefighters, and other public employees.
A 401k-type retirement account is basically a savings account. The value of the 401k-type account is simply the balance of the account. To divide a 401k-type account in divorce, you simply divide the part of that 401k account earned during marriage.
A traditional pension ("defined benefit"), in contrast, is a promise to make future monthly benefits until the participant (and perhaps a survivor beneficiary) dies. Dividing traditional pensions is much more complicated than dividing a 401k-type account.
There are two methods for dividing a traditional pension in divorce:
1) In the "deferred distribution method", the stream of monthly payments is shared at the future time when they the pension benefits begin. No money changes hands at the time of divorce. The divorce agreement and an associated document called a (Qualified) Domestic Relations Order (QDRO) specify a dollar amount or a formula for how the future monthly payments will be shared. The pension administrator consults the QDRO when the benefit payments begin.
2) In the "immediate offset" method, an actuarial present value is calculated for the pension. This is the theoretical value of the pension at the time of the divorce. The pension can then be treated like other assets such as real estate and divided. The pension participant "buys out" the spouse's interest in the pension by giving that participant other assets equal in value to 1/2 the marital portion of the present value.
In everyday language, the actuarial present value of a pension is the "cost of the promise to pay a pension participant a given monthly benefit until the participant dies." The cost of this depends on a) the amount of the future monthly benefit, b) how likely the pension participant is to die in any give year, and c) long-term interest rates.
You can calculate the present value of your pension instantly with an online pension present value calculator for about $50, or you can pay an actuary $175 to $300 and wait 1-3 weeks. The calculations require 1) your birth date, 2) the age at which you plan to retire, 3) the predicted amount of your future monthly benefit, and 4) the predicted amount of any cost-of-living adjustments that your pension has.