Defined Benefit and Defined Contribution plans

Retirement plans are divided into two types; defined benefit and defined contribution plans. Defined benefit plans pay a retired employee a fixed amount at either a regular retirement age or an early retirement age. For example, social security is a type of defined benefit plan. At a pre-determined retirement age, the employee is paid a fixed amount for the rest of their lives. The payment may or may not include a cost of living adjustment. Employees of most federal, state, county and city government jobs have a defined benefit plan.

Defined Benefit plans

For a Defined Benefit plan, a present day value is calculated by discounting the future cash flows expected from the plan at the regular retirement age. For example, the employee will receive $2,000 per month starting at age 65. The employee’s life expectancy is 80 years old. The total amount of pension payments is $360,000 ($24,000 x 15 years). The present value of those payments is an amount less than $360,000 to take into account the time value of money. In addition, a separate/community calculation is made for the time if any the employee worked before marriage.

Defined Contribution plans

Defined Contribution plans do not guarantee a fixed payment to retired employees. They instead depend on contributions from the employee and sometimes a matching contribution from the employer. Defined contribution plans include 401k’s, 403b’s, Roth IRA’s and Traditional IRA accounts.

If a party to a divorce has a defined contribution account, the current value of the account is included as a community asset. The account may have a separate interest if there was a pre-marriage balance. A calculation can be done that quantifies the separate and community interest in the ending balance. The post-marriage contributions are considered community property. The income and appreciation of the account is allocated into separate property and community property based on the pro-rata percentage of the separate and community balances on either a quarterly or annual basis for all years of the marriage.