§ 7.10 Pensions
| Jurisdiction | United States |
| Publication year | 2021 |
§ 7.10 Pensions
[1]—Introduction
Pension rights frequently represent a significant portion of the aggregate value of the marital estate. For this reason, divorce practitioners and judges must be conversant with the various types of pension plans and with the manner in which the employee's rights can change during the course of employment.
[2]—Types of Pension Plans
[a]—Defined Contribution Plans
Under a defined contribution plan, a separate account is maintained for each employee.355 Periodic contributions are made to the account pursuant to a prescribed formula, such as a percentage of the employer's profits or the employee's salary. Depending upon the plan, contributions are made solely by the employer, solely by the employee, or by both. Employee contributions are immediately vested; employer contributions vest according to a specified vesting schedule. Contributions to the account are invested by the plan administrator, and interest, dividends and profits accumulate in the account. Under a defined contribution plan, the aggregate amount in the employee's account at any time can be determined, since separate accounts are maintained for each employee.
When an employee retires, the retirement benefit received is the annuity that can be purchased at that time with the aggregate amount in the defined benefit account. If the employee quits or is fired prior to retirement, the employee's right to receive the money in the account depends upon a number of factors, such as whether the pension right has "vested" and whether the contributions were made by the employer or the employee.
[b]—Defined Benefit Plans
Under a defined benefit plan, a separate account is not maintained for each employee. A retirement benefit formula is established, and the monthly benefits due an employee are computed pursuant to the formula. The monthly benefits can be fixed at a specified amount. More frequently, however, the benefits are computed pursuant to a formula which contains a few variables. The most common variables are the employee's length of service and the highest monthly salary. An early retirement option is sometimes available. If the employee selects this option, monthly benefits are computed pursuant to a different formula. One large retirement fund is maintained by the employer, and the contributions are made to the fund according to actuarial computations. A representative defined benefit retirement formula would be, for example:
Monthly benefit = 2% x highest monthly salary during employment period x years of service.356
Contributions to a defined benefit retirement fund almost always are made solely by the employer. An employee normally must work a certain specified minimum "vesting" period before the employee qualities for a defined benefit pension. If the employee quits or is fired after being employed for the vesting period, the employee will receive retirement benefits if he survives until retirement age. However, the monthly benefit will be less than the pension that would have resulted from a longer period of service.
[c]—Hybrid Plans
Some government pensions are hybrids of defined contribution and defined benefit plans. For example, such plans may retire the employee to make contributions to the plan and separate employee accounts are maintained. However, the benefits from the plan normally are computed pursuant to a defined benefit formula. The employee's contributions establish a minimum benefit amount.357 Since the benefits are normally computed pursuant to a specified defined benefit formula rather than the employee's contributions, courts generally compute the value of such plans based upon the defined benefit formula.358
The computation is made more complicated because the amount of the benefits frequently depends upon whether the employee quits before retirement. If he quits before retirement, he may only receive the cash contributions. However, if he works until retirement, the benefits normally are much larger. The valuation of such "hybrid" benefits is significantly affected by whether the court assumes, for valuation purposes, that the employee will quit before retirement.
In most instances, courts treat such plans as normal defined benefit plans and assume the employee will remain employed until normal retirement age.359 For example, in a Maryland case, one spouse was an employee of the city of Baltimore. His pension was a function of his years of service, highest salary, and contributions made. The trial court valued the marital interest in the plan based only on his contributions to the plan during marriage. The Maryland court of appeals reversed, holding that the marital portion should be based on his actual benefits received, not his contributions during marriage.360
In an Arkansas case, the wife had a pension from the Arkansas Teacher Retirement System, which appeared to be a hybrid plan. The court valued the pension based on the amount she would receive if she quit at the time of divorce (essentially the aggregate value of contributions made), not the amount she would receive if she worked until retirement.361
[d]—Keogh Plans
A Keogh plan is a retirement plan created by a self-employed person. A Keogh plan can be a defined benefit or a defined contributions plan.
In a Nebraska case, the court addressed both alternatives. The method for calculating the non-employee's share was set forth if the employee quit before retirement and received a refund of his contributions, as well as what the non-employee's share would be if the employee received a retirement benefit based on the defined benefit formula.362
[e]—Individual Retirement Accounts
An IRA is an individual retirement account that can be established by an individual. Annual contributions may be made in any amount, up to the statutory maximum.363
[f]—Contributory Plans
Under a contributory plan, the employee makes some or all of the contributions to the plan.
[g]—Non-Contributory Plans
Non-contributory plans are funded totally by the employer.
[h]—Qualified Plans
A qualified plan is one that meets the requirements set forth in the Internal Revenue Code for tax-advantaged status.364 Contributions to a qualified plan may be deducted in the year made, and income can be accumulated in the pension account with no tax due. The employee does not have to pay tax on the benefits until benefits are received.
[i]—Non-Qualified Plans
A non-qualified plan is one that does not meet the requirements of the Internal Revenue Code for plans that will be accorded tax-advantaged status.
[3]—The Employee's Rights in the Plan
An employee's pension rights gradually changed during the course of employment.
[a]—Unvested Rights
An employee's rights are almost always unvested at least initially.365 During this period, the employee's rights can be divested if he dies, quits or is fired before the employee has been employed for the specified "vesting" period.366 Vesting can be either gradual or immediate. For example, some plans provide that an employee's rights remain completely unvested until the minimum vesting employment period is satisfied. After that time, the rights are fully vested. In contrast, other plans establish rules for gradual vesting.
If an employee quits or is fired when his pension rights are unvested, he loses those rights. The only exception to this rule occurs when the employer has a defined contribution plan, and the employee has made contributions. Employee contributions are immediately vested, regardless whether the employee's other pension rights are vested.
[b]—Vested Rights
Every plan provides that after a certain specified period of continuous employment, an employee's interest in the plan vests. After full vesting, the employee's interest in the plan is not subject to forfeiture if the employee later quits or is fired.367 For example, after full vesting the employee's rights to employer contributions to a defined contribution plan normally become nonforfeitable. In addition, under a defined benefit plan, the employee would be entitled to some monthly benefit at retirement even if the employee quits or is fired before retirement but after vesting.
Employees with fully vested rights do not always have a right to retire immediately. Under ERISA, rights under most qualified plans must fully vest within fifteen years, although many plans set forth a shorter period. Since early retirement is rarely possible before age fifty-five, it is obvious that not all employees with vested rights have a right to retire immediately.
Some courts have used the term "accrued"368 or "matured"369 instead of "vested" to describe non-forfeitable plan rights. This has added confusion to an area already possessing its fair share of complexity.
Vested defined benefit retirement rights remain subject to a significant contingency. If the employee dies before retirement, under most defined benefit plans neither he nor his estate receives any benefit from the plan.370
Retirement plan rights can vest incrementally, if the plan so specifies. It is therefore quite possible that the employee's interest at divorce will be partially vested.371
[c]—Matured Rights
An employee's rights are matured if he has a currently exercisable right to retire.372 The employee's enjoyment of matured defined benefit rights remains uncertain; if the employee dies before retirement, the benefits may be lost.
Even if rights are "matured," the employee might receive a discounted benefit if the employee elects to take "early" retirement.373
In its discussion of what constitutes a "mature" pension benefit an Arizona court stated that this is the time when the employee could retire and receive the "normal" benefit, as opposed to a discounted benefit due to early retirement.374
[d]—Rights in Pay Status
Once the employee has retired, his rights are in pay status.
[e]—Accrued Rights
All of the employee's pension rights earned through the date in question are considered "accrued" rights.375 Accrued...
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