Money that you have today is worth more than money you will get tomorrow. It’s kind of like “a bird in the hand is worth two in the bush.”
This wisdom plays into lots of divorce cases I work on; I’d say that pensions figure in about a quarter of them.
To be more specific: I help divorcing women, and the attorneys who represent them, to properly figure out what the husband’s pension should be worth, as it pertains to the settlement.
This is not simple.
Correction: It can be. I mean, if it’s all community property (details in a minute), then it’s basically just a QDRO (or DRO if it’s a government pension), and the husband and wife each get the same payout, month after month, after the divorce.
But it’s usually not that simple.
Taking your lumps
First off, if the husband started his job—and thus contributing toward his pension—before he got married, then that pre-marriage portion is not community property. How much is that portion? Well, that takes some tracing, and some calculations by a CPA like me.
Second, the husband who worked all these years at this big job of his, will often feel that that pension money is his. And, often, the soon-to-be ex-wife would prefer a big chunk of cash rather than a monthly payment; this can be more beneficial to her in case of the husband’s early death.
Thus the lump-sum buyout. Assuming that the husband has opted for a joint-survivor disbursement of the pension at retirement, he and the wife will be entitled to future money.
But the wife wants it now. And as I’d noted above, money today is worth more than a future stream. That’s why it gets discounted when paid out, as a lump sum, at settlement; it would be, effectively, cheaper, for the husband to simply let the monthly payouts go according to schedule.
Which brings up the thorniest question of all: How much should it be discounted?
Look, this is a newsletter, not a textbook. So just know there are different factors involved, each of which is complex, and none of which is black-and-white. As an attorney, I know you’re immediately perking up here, because this translates to “room for negotiation.” And it’s my job—my expertise—to help build the best case. Consider some of these factors:
- Life expectancy. To get the maximum amount over the wife’s lifetime, you need to have your best possible estimate of how long that will be. There are different life-expectancy actuarial tables that I like (and others that I don’t), and will use the best one(s) for your client.
- Years until retirement. My argument is that the discount rate should be equivalent to what someone should reasonably expect to earn on that money if they took it out as a lump sum. But what’s “reasonable”? For a still-working husband, it might be an aggressive return on the order of eight percent. For a stay-at-home mom, it might be a much more conservative five percent.
- Tax rates. This comes into play when the husband will be receiving another asset to offset the lump sum. Tax rates are based (among a zillion other things) on income. If the husband will be earning more than the wife in the future, whose rate do you use to compare the pension and the other asset? Do you meet in the middle? All this factors into the negotiation of the discount rate.