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Pensions, Divorce, and the “Hunt” Formula

Dividing Pensions Using the “Hunt” Formula in Colorado

“What?!! He/she gets a part of my pension?!!” That is sometimes the response I get from a client when I tell him or her that at least a part of his her or pension, for which the client has worked hard over many years, is a kind of “marital property” that the court will divide between the parties getting divorced.

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It’s true. Even an unvested interest in a pension, meaning that you are not yet guaranteed to the receive the pension, is a form of marital property that can be divided between the parties by a Colorado divorce court judge.

(A “vested” interest in a pension means you have a guaranteed right to receive a pension on or after a certain date. A “matured” interest in a pension means you have actually retired and are actually receiving the pension benefit or have just retired and are ready to receive your first payment of the benefit.)

 

Distinguishing Defined Benefit Retirement Assets from Defined Contribution Retirement Assets

Before we go any further let’s distinguish a pension, which is a kind of “defined benefit” retirement asset, from its sibling, the “defined contribution” (“cash balance”) retirement asset. A defined contribution retirement asset, of which the most common are the 401(k), 403(b), and IRA, has a “cash balance”, hence the alternative name. Every month, quarter, year, or whatever, you receive a statement. The statement shows what the defined contribution (“cash balance”) retirement asset is worth. It is fairly simple (simple being a relative term) to divide a defined contribution retirement asset between the parties because it has a known value, right now. The court can slice off a piece of that value and give it to the other party to the divorce.

(To read my blog post concerning dividing cash balance retirement accounts upon divorce, click here.)

A defined benefit retirement asset, on the other hand, does not have a “cash balance” aspect to it. It is usually a promise by an employer to pay you a certain amount of money per month, based on a formula they have come up with, if you meet certain requirements set by the employer and then retire. Most of the time, the requirements are to work for a certain number of years for the employer and/or attain a certain age before retiring.

The most common defined benefit retirement asset is the classic “pension”. Fewer and fewer employers offer a pension retirement benefit, but some still do. Government, military, labor union, and railroad pensions are examples of the classic pension benefit that still exist in great numbers.

 

Pensions and How to Divide (“Distribute”) them Between the Parties

So, what do we do with a pension when two people get divorced? Of course, the employee spouse who is working for the employer offering the pension might say, “I keep it, and he/she can fend for himself/herself upon retirement.” That is not generally how it plays out in the divorce case. The court, and the non-employee spouse, see the issue differently. The non-employee spouse says, “We were both looking divide money icon 256forward to enjoying the retirement benefits of my soon to be ex-spouse. There was never any discussion during the marriage that only the employee spouse would enjoy the pension upon retirement.”

That is also how the court, and Colorado law, views the pension. All of the pension, or a piece of it, is “marital property”, regardless of whose name is on the pension. The marital property piece of the pension must be divided between the two parties to the divorce.

So a court must determine how it will “distribute” (divide) the pension between the two parties to the divorce. A court basically has three different methods it can choose from to divide the pension:

1) Net Present Value

The court can use an accounting and valuation principle called “net present value” to divide the pension. With this method, an expert of some sort, using actuarial tables, risk factors, discounts, et cetera, comes up with a dollar value number for the “worth”, right now, of the future right to receive a pension. The expert says that the likelihood of receiving the pension, in the future, is worth X dollars, right now. That is the net present value of the pension.

The court will then assign a piece of the net present value of the pension to the non-employee spouse. The method the court uses to determine the fraction of the net present value the non-employee spouse receives is the “coverture” method (see section 3, below, for more on the coverture method).

Once the dollar value of the non-employee spouse’s fraction of the net present value of the pension is known, other property, such as cash, a house, a car, stocks, bonds, Mickey Mantle rookie baseball cards, et cetera, is used to pay the non-employee spouse the value of his or her part of the pension. In essence, the employee spouse is “buying out” the non-employee spouse’s interest in the pension. Upon retirement, the employee spouse gets the full benefit of the pension.

The net present value approach works best when the amount of the pension is small or the employee spouse has only worked a few years for the employer offering the pension. This method also works best when other property, such as cash, exists to “buy out” the non-employee spouse’s interest in the pension.

2) Reserved Jurisdiction (Wait and See)

The court can use a legal principle called “reserved jurisdiction” to put off the dividing of the pension until the time that the employee spouse actually starts receiving the pension (or is eligible to receive it). At that time, the court will determine what portion of the pension benefit the non-employee spouse receives.

Reserved jurisdiction is chosen by the court only rarely as it leaves the parties “in limbo”.  The parties do not know how the pension will be divided until retirement time actually arrives for the employee spouse.

3) Deferred Distribution

The court can use a method of dividing the pension that is known as “deferred distribution”. This is sort of a compromise between the net present value and reserved jurisdiction methods. Using the deferred distribution method, the court will determine a percentage of the pension benefit that represents the marital fraction of the pension benefit. The court will then determine what percentage of the marital fraction percentage of the pension to allocate to the non-employee spouse. This final number (a percentage of a percentage) that is allocated to the non-employee spouse is a portion of the monthly pension benefit the employee spouse is entitled to. The exact monthly dollar amount the non-employee spouse will receive is not yet known as the employee spouse has not yet retired. When retirement time arrives, however, the non-employee spouse will get the court-ordered X percent of whatever monthly benefit the employee spouse receives.

The leading case in Colorado that explains these three methods of dividing a pension asset is In re the Marriage of Hunt, 909 P.2d 525 (Colo. 1995).

More About Deferred Distribution

Colorado divorce court judges most often choose the deferred distribution method to divide a pension upon divorce. It has the advantage of certainty, in that the non-employee spouse knows that he or she will get the court-ordered X percent of the eventual monthly pension benefit. At the same time, it avoids the cost of expert witnesses of the “net present value” method and the wait time of “reserved jurisdiction” method.

The two-step, “percentage of a percentage” calculation was explained well in the Hunt case. That is why it is sometimes referred to as the “Hunt formula.”

First the court calculates the total length of time (in years or months) that the employee spouse has worked (or will work) to get to retirement age with his or her employer. The total length of time the employee spouse will work, from signing on with this employer, to the date the employee spouse becomes eligible to retire with full retirement benefits, is first determined.

For example, if the employee spouse began working for the employer on January 1, 2000, and is eligible for retirement with full benefits as of January 1, 2025, there are 25 work years before the pension benefit begins.

Once the total length of the employee spouse’s work years or months are determined, then the court determines how many of those years or months occurred during the marriage. That is fairly easy to do. To return to our above example, let’s assume that the employee spouse gets married to the non-employee spouse on September 15, 2005, and the divorce decree date is scheduled for September 15, 2017. That is 12 years of marriage, all of which overlaps the employee spouse’s work years for the employer. The 12 years are the “marital” years of the pension work years.

There are 12 marital pension work years and 25 total pension work years. Dividing 12 by 25 is .48 or 48 percent of the pension work years. The marital fraction of the pension (also called the “coverture” fraction) is 48 percent.

So, does the non-employee spouse get 48 percent of the pension benefit? No.

Why not? Because both the employee spouse and the non-employee spouse have a 50 percent interest in the marital fraction of the pension.

So, what does the non-employee spouse get?

The non-employee spouse gets 50 percent of the marital fraction of the pension benefit. The marital fraction of the pension benefit is 48 percent. So, the non-employee spouse gets 50 percent of 48 percent, or 24 percent of the entire pension benefit. When the employee spouse retires, or becomes eligible for retirement, the non-employee spouse is entitled to a retirement benefit of 24 percent of whatever retirement benefit the employee spouse receives or is entitled to receive.

So, as of the date of the divorce decree, the non-employee spouse knows what percentage of the retirement benefit he or she will receive but does not know what dollar amount he or she will receive.  This is because the actual pension monthly benefit is not yet known.  The non-employee spouse has to wait until the employee spouse actually retires, or becomes eligible for retirement, before the non-employee spouse knows what amount of money his or her percentage of the pension benefit actually represents.

Let’s say that the employee spouse in our example reaches full retirement eligibility and retires. The retirement benefit is, say, $4,500 per month. The non-employee spouse will receive 24 percent of that monthly benefit, or $1,080 per month. The employee spouse will receive the remaining $3,420 per month.

(Note that, because the court is going to use the date the employee spouse is eligible for full retirement with the employer, not the date of divorce, to determine the number of work years, it seems like the non-employee spouse is getting the benefit of the employee spouse’s hard work after the parties are divorced. This is irritating to some employee spouses. They may complain, understandably, that their pension’s value may go up because of their efforts after the divorce. For example, they may get raises after the divorce, perhaps merit raises or promotions, and those raises or promotions will increase the value of the pension they ultimately receive. The ex-spouse had nothing to do with those post-divorce raises, an employee spouse will argue.  The Colorado Supreme Court, however, has decided to reject this argument. See the Hunt case, above.)

 

But Wait, it Gets More Complicated

Now, pensions are complex legal creatures. Pensions are also creatures of their own terms. You have to read the pension plan documents carefully. Also, unexpected things happen, such as the employee spouse dying before the pension vests or before reaching retirement eligibility. Maybe the employee spouse changes jobs or gets laid off before having any vested interest in the pension. In our example, if the employee spouse, for whatever reason, never gets a vested interest in the pension, the non-employee spouse has a 24 percent interest in… nothing. Multiplying zero by .24 is still zero.

So, when negotiating a settlement or arguing to the court about how to divide a pension, especially an unvested and/or unmatured pension, consider carefully what you are giving up for a pension benefit that might never be given to either spouse.

A careful divorce lawyer will look carefully at the pension documents. Does the pension have some sort of death benefit for a current or former spouse? If not, can the employee spouse “change his or her election” with the pension plan so that it does? When does the death benefit vest? When will the interest in the pension vest?

During settlement negotiations, if there is a real possibility that the non-employee spouse will never get his or her portion of the employee spouse’s pension benefit, the attorney for the non-employee spouse should think hard about what is being given up in return for a pension benefit that may never be received. Is the non-employee spouse being asked to give the employee spouse a portion of a 401(k) or other cash balance account when the corresponding pension benefit from the employee spouse isn’t vested yet and may never be vested? It doesn’t sound like a fair trade because the 401(k) has a real cash value, today, and the employee spouse will get real, “today” value when he or she gets a piece of the 401(k). The non-employee spouse may never get a piece of the employee spouse’s pension if unexpected (or maybe even expected) events occur in the future.

Before signing any separation agreement with a soon-to-be former spouse that includes provisions relating to a pension, consult with a divorce attorney who understands pension issues to make sure the agreement is really fair to you.

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