A Pension Valuation in Payout Status!

Every so often you have a divorce situation where the client is a current recipient of a monthly pension income or annuity stream. Valuing a pension in pay-out status incorrectly can be very hazardous to your participant-client's financial health. It requires a complete understanding of annuity pay-out options.

At the time benefits commenced, the participant was required to elect an annuity pension income option. What is very important to understand at this point is that the election of this benefit is IRREVOCABLE. Not even a court order or Qualified Domestic Relations Order can require the Plan to change or reverse the election.

We have noticed in this situation that many evaluators will simply value the monthly income over the participant's life expectancy and arrive at a "present value". This is incorrect and only tends to overstate the actual present value to the participant. The reason is simple to understand. Since the participant elected a joint and survivor annuity option, the soon-to-be-ex-spouse will receive a percentage of the annuity amount at the participant's death, regardless of how long they live beyond the death of the participant. Therefore, it is only logical to value the pension income based upon the participant's life expectancy. However, an additional present value calculation needs to be completed based upon the surviving spouse's life expectancy and subtracted from the participant's original present value.

For instance, assume you represent a participant in a defined benefit plan who is currently in receipt of their monthly retirement benefit. Further assume that upon retirement, the participant elected a 50% joint and survivor election naming the spouse as the beneficiary. For simplicity, we will assume the monthly benefit the participant is receiving is $1,000 per month, the participant is a 65 year old male with a life expectancy of 80, and the spouse is female also age 65 with a life expectancy of 84. Life expectancies can be found by referring to the Vital Statistics of the United States 1995, Volume II, Section 6, Table 6-3, Expectations of Life at Single Years of Age, by Race and Sex, page 12, published by the U.S. Department of Health, Education, and Welfare Public Health Services, May 1998.

Statistically, the spouse will live four years longer than the estimated age of death of the participant. This then means that the spouse will receive $500 per month for the remainder of her life or for 48 months. This survivor benefit will then have to be brought back into present value terms using both a present value of annuity formula and for that of a lump-sum. That is, the present value of this series of payments will be brought back into a lump-sum present value at the date of the participant's estimated life expectancy using the present value of annuity formula, or a financial calculator. This present value then becomes the future value used in the present value of a lump-sum formula. This second step will bring the lump-sum value at the participant's estimated date of death into current dollars. It is this present value, the value of the survivor benefit, that must be subtracted from the overall present value of the participant's retirement plan.

Lastly, this concept pertains primarily to private non-governmental plans. Many governmental plans, along with military plans, will allow the participant to change the beneficiary but again not the option, i.e. 50% joint and survivor annuity. If you recall when it comes to privately funded plans, the option nor the beneficiary can be changed after retirement. Questions related to these issues may be directed to Tim Voit by calling toll-free: 1-800-557-8648, or e-mailing us