Defined Benefit vs Defined Contribution Retirement Plans – You’re probably asking yourself, “Why in the world would we write about retirement plans in a family law blog?” Well, when it comes to the just and right division of property between divorcing spouses, the type of plan one or both spouses participate in affects how benefits will be characterized, valued, and divided after the marriage is over.
For the purposes of this blog, we will talk about qualified retirement plans. This blog will define what a qualified retirement plan is, the two generic types of these plans, and how this relates to divorce.
Per the Texas Family Code, when a plan is qualified, both the employer and the employee receive favorable tax treatment under the Internal Revenue Code. For example, the employer can deduct any contributions it makes to the plan on behalf of its employees, the employee is not immediately taxed on the contributions made on her behalf, and any investment gains in her plan are tax-deferred until the benefits are withdrawn.
In a divorce, the courts can assign any portion of a participant’s qualified retirement benefits to a former spouse.
There are two generic types:
Defined-Contribution Plans
You may not recognize the term “defined-contribution” plan, but it includes many recognizable financial vehicles:
- 401(k) plans
- Employee stock-ownership plans
- Money-purchase pension plans
- Profit-sharing plans
- Thrift plans
- Keogh plans
In a defined-contribution plan, both the employee and employer contributes money or stock to an individual account held in the employee’s name. The contributions are usually based on a percentage of the employee’s salary while the value of the employee’s account will depend on the amount of contributions made, plan and income expenses, and the gains and losses of the account’s investments. The employee gets the full balance of the account upon retirement.
Defined-Benefit Plans
This plan type is slightly different in that an employer generally agrees to pay an employee a monthly defined benefit from the date of retirement until the employee dies. A defined-benefit plan can still be considered qualified even if the plan makes distributions before retirement to employees who are 62 or older. A defined-benefit plan usually makes payments to participants with an annuity, which is a stream of monthly payments that continue until some date is reached or some condition is met (usually until the death of the participant).
There are various types of annuities, and knowing the difference is crucial in terms of a divorce proceeding.
- If a participant has already elected a form of annuity payment when his marriage is ending, that election will affect how future payments of the participant’s retirement benefits will be paid to the other spouse if that spouse is awarded a percentage of those benefits.
- If a participant has not elected an annuity payment at the time of divorce, the participant’s spouse will need to elect which annuity they want to receive, which will affect the participant’s elections.
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