State Pensions: What You Need to Know

As a Certified Divorce Financial Analyst® (CDFA), I spend a great deal of time educating my clients about their state pensions. There is much confusion surrounding division of retirement assets in divorce especially when it comes to pensions (Defined Benefit Plans). A pension is considered a marital asset and is commonly divided in a divorce so that the spouse who does not have the pension, receives a percentage of the pension benefit when the other spouse retires. This type of division is governed by the domestic relation laws in the state that the divorce is taking place in. However, I find that most people, their attorneys and/or mediators do not have a clear understanding as to how to divide a pension, how to value it or even what the annuity savings account is.

Understanding Annuity Savings Accounts

I have many clients who work for the Commonwealth of Massachusetts and participate in the state pension plan. A prospective client, a teacher in the public school system, told me yesterday that she did not really understand the difference between her pension and her annuity savings account. She told me that their mediator was listing the value of the annuity savings account on her side of the retirement assets, which would be used in equalizing the total balance of retirement assets so they could determine who owed who what. Unfortunately, listing the annuity savings account as a retirement asset is a big mistake and if actually divided, it would have devastating future implications for our teacher.

All MA state employees are required to contribute a percentage of their earnings to the pension plan in the form of payroll deductions. For a teacher who is in the Massachusetts Teachers’ Retirement System (MTRS), that contribution percentage is 11% of their regular salary. These mandatory retirement contributions are placed in an account called the annuity savings account. For teachers, this account is maintained by the MTRS on their behalf, for their future retirement.

There are two sources of funds used the pay out a pension benefit when the employee retires; the general pension fund and the employee’s annuity savings account. When a state employee commences their pension benefit, their annuity savings account is used by the Retirement Board to help fund the employee’s monthly pension benefit. If the annuity savings account is refunded in full and depleted prior to retirement, which it can be under certain circumstances, then the employee’s right to their pension is gone, or forfeited.

Back to our teacher. While she is still employed and contributing to the MTRS, she is not eligible to withdraw any portion of the annuity savings account (because it will be used to help fund her future retirement benefit). She is also not able to borrow money from the account nor assign the account to anyone else (some exceptions apply). As the MTRS says in their Q&A guide entitled ‘What You Need to Know as a Party to a Domestic Relations Order’, “your annuity savings account is not a personal bank account or an individual retirement account”. It is for this reason, that the balance in the annuity savings account cannot and should not be listed as a retirement asset on their “side of the ledger” for division purposes. It’s an account that cannot be accessed therefore it does not belong in the marital pot for division.

If the parties agreed that her future pension benefit will be divided pursuant to the divorce, and, the balance of her annuity savings was also listed as an asset on her side, you can see that doing this would constitute ‘double-dipping’. Since the annuity savings is used to help fund the pension, it is by default being counted as an asset when the pension is divided.

Annuity Savings Balance in Not the Value of Your Pension

The balance in the annuity savings account is NOT the value of the pension; the only way to determine the ‘value’ of the pension is with a Present Value calculation done by a financial professional. However, the only reason we perform a valuation is if there is another asset of equal value that can be traded in lieu of dividing the pension. Pensions are highly emotional assets, and the thought of having to give a portion of your hard-earned pension to someone else can be daunting and seemingly unfair. If you want to “keep” your pension and not divide it, then a valuation needs to be done.

For those people who are vested and who are close to retirement, that pension can be worth over $1,000,000. If the divorcing couple only have the pension and a home and maybe a few other smaller accounts, it is unlikely that a pension worth over one million can be offset.

Exceptions and Considerations

It was mentioned earlier that if someone takes a refund (withdrawal) of their contributions, they will forfeit their future pension benefit. By now, it should be clear why this would happen. But sometimes, the balance of the annuity savings account can be included in the list of assets and sometimes, it may be appropriate for someone to take the refund.

If our teacher above only had 8 years of service, then we would include the balance of the annuity savings account as an asset, because she has not yet earned a pension benefit. In Massachusetts, you must have at least ten years of service to be entitled to a pension benefit; under 10 years, the employee is entitled to take a full refund of their annuity savings account because they have not yet earned a benefit. Since there is no pension to divide pursuant to the divorce, we can use the balance of the annuity savings account as an asset on the teacher’s side of the ledger. But, this does not mean that the account can be divided. On the contrary, if our teacher is still employed and making contributions then she is unable to take a refund. However, if she knew teaching was not for her and she didn’t want to wait until she reached 10 years of service, she could quit and take a refund. But then any future possibility of getting a pension is gone.

For retirement asset equalization purposes only, we use the balance in the annuity savings account if someone has less than 10 years in the pension system. But only with the understanding that the account cannot be physically divided. The transfer payment from one spouse to the other, will have to come from some other retirement account and not the annuity savings account.

Most people that are vested in their pension will continue to work until they have reached their normal retirement age or their maximum benefit. For our teacher, she can retire at any age, with 20 years of creditable service, or age 55 with 10 years of creditable service. If she worked for 30 years, she would receive an “enhanced benefit” (RetirementPlus) of an additional 12% added to the allowable “percentage of salary average”. As you can see, it does not make financial sense to take a refund before reaching retirement age and lose out on such a valuable asset, even if it may eventually be divided in the divorce.

Why You Should Work with a CDFA®

After speaking with my prospective teacher client and explaining all this to her, she couldn’t believe how much she had learned and how much more informed she was with regards to her pension. She hired me on the spot to help support her as she continued to attend mediation. Having that clarity and confidence is essential to receiving a divorce settlement that is fair, equitable and meets your needs, concerns and goals. Working with an experienced CDFA® is the best way to ensure that your assets are properly accounted for and divided correctly. Contact me, Diane C Pappas, CDFA®, CQS™ at diane@solutionsfordivorce.com or by calling me at (978) 833-6144 for a free 30-minute consultation. Or use this link to my calendar: https://calendly.com/dianepappas/30min