Evaluating Pension Benefits in Divorce

By Pope, Ralph A. | Journal of Accountancy, August 1993 | Go to article overview
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Evaluating Pension Benefits in Divorce


Pope, Ralph A., Journal of Accountancy


Once CPAs have become familiar with pension valuation and developed referral sources, they will be able to offer a service for which there's growing demand.

CPAs generally have overlooked the consulting opportunity available in evaluating pension benefits in marital dissolutions. Millions of American workers participate in retirement plans - and a large percentage of marriages end in divorce. When a marriage is ending, the future benefits of an employee's retirement plan often are a hotly contested item.

CPAs have let economists and actuaries take the lead in this lucrative business, although accountants are particularly well suited for it because they have the proper training, knowledge and problem-solving ability. CPAs' educational background in present value analysis, finance and law, as well as their training in examining complex issues, constitute the needed foundation on which to build an expertise in the area of pension valuations.

The Pension Benefit Guaranty Corporation (PBGC) developed a set of actuarial and mortality tables that are being used in pension plan valuation in divorce cases. Also, there are excellent sources of published information available to illustrate the evaluation process.

PENSION BENEFIT GUARANTY

CORPORATION

The PBGC was established under provisions of the Employee Retirement Income Security Act of 1974 (ERISA) to provide pension benefits in plan terminations. Its purpose was to ensure that workers earning retirement credit would not lose their benefits if a company went bankrupt or if the plan terminated for other reasons.

The PBGC's actuarial factors used to value the benefits of terminated plans were published in the Prospective Actuarial and Mortality Tables. In recent years, these tables have been used more and more in the valuation of pension plans in divorce cases.

Prospective Actuarial and Mortality Tables contains a set of 21 actuarial tables for immediate annuities at interest rates ranging from 6% to 11%, as well as the mortality tables on which the actuarial tables are based. The current interest rate used can be obtained by telephone or by getting on a monthly mailing list from the PBGC. (The address for relevant information is PBGC, communications and public affairs department, 2020 K Street, N.W., Washington, D.C. 20006-1806. The current immediate PBGC annuity interest rate can be obtained by calling [202] 778-8899.)

PENSION VALUATION IN MARITAL

DISSOLUTION

Evaluating the cash flows of future pension benefits involves determining the cash flows' actuarial present value. This means discounting for interest, for mortality and, when applicable, for vesting. As will be seen, the task can be simplified by using the PBGC tables.

For example, John Brown and his wife are in the process of dissolving their marriage. Mr. Brown participates in a retirement plan at work. Determining the value of his retirement benefits is an important part of the divorce deliberations. Exhibit 1 on page 64 shows important dates and information for Mr. Brown.

Pension specifics. Mr. Brown is a healthy male who is fully vested in a defined benefit plan. In a defined benefit plan, retirement payments are determined by a formula based on factors such as years of service under the plan, the participant's average salary before retirement (for example, that of the last three years) and the participant's age at retirement. In almost all cases, the value of a defined benefit plan is more difficult to calculate than the value of a defined contribution plan. In a typical defined contribution plan - such as a profit-sharing plan - value usually is determined by the individual's balance in his or her account at a specific date.

In this example, pension benefits for Mr. Brown's plan are determined by multiplying each year of service by 0.02 (or 2%). This value is multiplied by the average of the last three years of the employee's compensation, which is $60,000.

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