The Two Types of Pensions
Pensions are obligations by an employer to an employee due at retirement. There are generally two kinds of pensions: defined benefit plans and defined contribution plans. A defined benefit plan provides a specific benefit amount at the time of retirement (usually based on length of service and salary at retirement); a defined contribution plan features a specific amount to be contributed by the employee during the employment, but the actual benefit paid out is not determined until the employee retires.
Pensions are contractual obligation by the employer to the employee; an employee’s pension is not contained in a separate “account”, which is why employers can use funds earmarked for pension obligations for their operations, and why pensions can sometimes become underfunded, as discussed below.
Defined contribution plans are more easily divided in a divorce. Since an employee has contributed a specific amount, the value of the pension and the amount contributed by the employee during the marriage can be more easily determined. At that point, a divorcing spouse can easily be awarded his or her marital interest from the employee spouse.
Defined benefit plans are more difficult, because the amount of the pension is not known during the divorce, and will not be determined until the employee spouse retires, which could be years, even decades later. Moreover, the marital interest is much more difficult to define, and therefore much more difficult to determine. Generally, the divorcing spouse’s interest is determined as if the employee spouse retired at the time of the divorce. However, this benefit will not be paid to the spouse until the employee retires or goes into pay status, which can be years later.
Problem Areas with Pension Plans
Underfunded plans – If an employer’s business fails, it is very possible that the pension is underfunded or terminated, and there may not be sufficient funds to provide the employee or the divorced spouse with any retirement proceeds. While government regulations may provide some minimum guarantees, this may not come near what divorcing parties expect at the time of dissolution. Therefore, if there is any concern that an employer providing a pension may have financial difficulties, that the parties value the pension appropriately, with the non-employee spouse possibly looking to other assets.
Bankruptcy – If an employer files for bankruptcy, the employees’ interest in the pension plan is a claim on the bankruptcy estate and is subject to the same hopes and minimum guarantees as an underfunded plan as a result of a business failure.
More commonly, the employee or his or her former spouse will file bankruptcy. Generally, an employee’s interest in a pension plan will not be includable in a bankruptcy estate. Therefore, creditors will not be able to attach that interest or those funds. The situation would be different once pension funds are distributed to the employee and deposited in their personal accounts. Even if an employee spouse files for bankruptcy, this would not jeopardize the former spouse’s interest because pension benefits are not paid by the employee, but is an obligation from the employer to the former spouse.
Forfeiture for Cause - A particularly difficult problem arises in the case of forfeiture of pension benefits for cause by the employee spouse. In the case of employee misconduct, for example, an employee could forfeit his or her interest in a pension. If the employee is required to pay funds for criminal restitution, this may be taken as against the employee’s pension benefit. A former spouse with an interest in that pension may have that interest defeated with little recourse.
Death of an Employee – A non-employee spouse’s interest in a pension can be similarly defeated in certain situations when the employee spouse dies prior to receiving benefits, such as defined benefit plans being paid as an annuity over the course of a single life.