Most employers offer options for employees to participate in employee benefit programs as a way to reduce the amount(s) they pay in salaries each year. Many employee benefit plans offer great tax advantages for both employers and employees, so they tend to be incredibly popular. If you are considering a divorce in California you should understand how your employee benefit and retirement plans will be affected.
Retirement Benefits Considered Community Property
Most employee benefits are considered community property in California. Defined benefit plans (e.g., employer pension plans and cash balance plans), defined contribution plans (e.g., 401(k), 403(b), employee stock ownership plans, employer profit-sharing plans, stock bonus plans), and independent retirement plans (e.g., IRA, SEP IRA, Roth IRA) are considered to be community property. In California, divorcing couples split community property 50/50, unless otherwise noted. For example, a prenuptial agreement may explicitly state that one spouse receives 35% while the other receives 65%.
Valuing Retirement Benefits in a Divorce
So, we know that these retirement benefits are community property, but how are these benefit plans valued during a divorce? The process of dividing retirement plans can be complicated and often requires additional expenses and court intervention.
The type of plan involved (defined benefit vs. defined contribution) will often dictate how complex the process will be. Valuing a defined contribution plan is generally easier than valuing a defined benefit. If you have a 401(k), you know the value of your account each month. Generally, with a defined contribution plan, you get out of the account what you put in. Defined benefit plans, on the other hand, can be more difficult to value. An actuary must determine either (a) the present value of the plan or (b) the expected future value of the plan.
Dividing Community Property Retirement Assets in a Divorce
Divorcing spouses often choose between two options to divide retirement benefit assets. The first is known as reservation of jurisdiction. This option uses a court order (known as a Qualified Domestic Relations Order, or “QDRO”) to assign a percentage or amount of an employee spouse’s retirement plan to the non-employee spouse. If, for example, let’s say husband and wife decided to get a divorce, and the husband had a pension plan through his employer. Using a QDRO, they could opt to assign half of that pension plan to his wife. The wife would be able to start receiving retirement benefits as soon as the husband is eligible for retirement with his employer, regardless of whether he actually retires on that day. The wife would only be entitled to receive 50% of the benefits that accrued while she was married to the employee.
A QDRO can be an extremely complicated and nuanced document. Many retirement plans are regulated by the Employee Retirement Income Security Act (“ERISA”), which prohibits retirement benefits from being assigned to anyone other than the employee who earned them. State law – including California’s community property provisions – are pre-empted by ERISA. A QDRO is an exception to this strict rule.
However, a QDRO must follow explicit guidelines and include very specific details. A plan administrator will determine if a QDRO is valid. A valid QDRO, at the very least, will contain the name of the non-employee spouse who should receive a portion of the benefits, the specific amount or percentage that they will receive, the specific account that will receive benefits from, and the duration or number of payments. To ensure that your QDRO is valid you should contact an experienced attorney.
The second option is known as a cash out. This option requires an actuary to determine the present value of the employee benefits that accrued during the marriage. The non-employee spouse is then awarded community property equal to the value of the employee benefits. The employee spouse retains the right to receive all of the benefits.
Social Security Benefits Considered Separate Property
The Social Security Act explicitly states that the right to future Social Security payments is not transferable nor assignable. California state law is preempted once again. This time, however, this is no QDRO option. This means that regardless of whether the Social Security benefits were accrued during marriage they will be considered the separate property of the spouse who earned them.
There are certain situations where this can result in an inequitable division of assets. Government employees are prohibited from receiving Social Security benefits under the Social Security Act’s Windfall Elimination Provision.
So, let’s say that Spouse A works for a private employer and contributes to Social Security and Spouse B works for the government and does not contribute to Social Security, but does contribute to a pension plan. By law, Spouse A is entitled to all of his Social Security benefits and half of Spouse B’s pension benefits. Spouse B is not entitled to any of Spouse A’s Social Security and must give him half of the pension benefits accrued during the marriage. Spouse A clearly walks away with more in this situation.
California courts have declined to offer a solution to this inequitable division of marital assets. A wife, who was in Spouse B’s shoes, petitioned the Second Circuit Court of Appeals and asked them to divide their marital assets equally by giving her husband’s Social Security the essence of community property. She asked that they calculate the value of her husband’s Social Security that she would have been entitled to had it been considered community property.
She then requested that they use this value to offset the amount of her pension that was available to him as community property. (If the value of Social Security benefits she would be entitled to under community property rules was calculated to be $10,000, she asked that they reduce her husband’s right to her pension by $10,000.) The court clearly agreed that the division was inequitable, but declined to order a division of the assets in this way. Social Security will always be considered separate property until Congress and/or the California legislature takes action to change this policy.
Dividing employee and retirement benefits can be complicated and should be handled by an experienced attorney. Contact our office today to learn more.
Fernandez & Karney
429 Santa Monica Blvd Suite 120
Santa Monica, CA 90401
https://www.cfli.com