What is the difference between a “defined contribution” plan and a “defined benefit” plan?

In many divorces, retirement plans are one of the two most valuable assets. However the process of valuing and dividing “defined contribution” plans is very different than for “defined benefit” plans. It is vital to understand the difference between these two types of plans.

A defined contribution plan is one in which an employee (and sometimes his or her employer) makes periodic contributions in an account. Typically these accounts are Thrift Savings Plans (TSP’s) for government employees, Individual Retirement Accounts (IRA’s) for self employed individuals, 401k’s for employees of private businesses; and 403b’s for employees who work for non-profits. The value of such plans is simply the amount in the plan. For equitable distribution purposes, a TSP with $150,000 on the date of filing is valued at $150,000 (although the court can alter the amount subject to equitable distribution if some of the TSP is premarital or if there is post-filing passive appreciation or depreciation in the value of the TSP).

A defined benefit plan is one that guarantees an employee a fixed amount of periodic (typically monthly) retirement funds beginning on a set date (typically upon retirement or reaching a particular age) and ending on the employee’s death (although most defined benefit plans offer a survivor benefit option that pays a set percentage of the benefit if the designated survivor outlives the employee). Often these plans have cost of living adjustments that raise the benefit amount over the years. These plans were very common in the 1950’s to 1980’s but are less common today. They are most common with government and union employees.

The owner’s life span has no bearing on the value of a defined contribution plan. The assets in such plans can be distributed as part of the estate when the owner dies. In contrast, the owner’s life span (and the designated survivor’s life span if there is a designated survivor) has tremendous bearing on the value of a defined benefit plan. Someone who dies before he or she begins receiving benefits from a defined benefit plan receives nothing. However some folks receive these benefits for 40+ years.

Since a defined contribution plan has a fixed value, it is easy to value and divide. However, since a defined benefit plan has no fixed value, it is hard to determine what a fixed dollar “equitable” division would entail. While one can hire an actuary to value a defined contribution plan, such valuations are highly variable depending upon the retirement date, life span, inflation rate, and interest rate assumptions that are used in the valuation. It is not uncommon for opposing parties’ valuations to differ by over 100%. Many a divorce litigant who has agreed to divide a defined contribution plan by asking the court to give the plan a set value and dividing that value has been extremely unhappy if the judge accepted the other party’s valuation.

Because of valuation concerns, I am disinclined to value defined benefit plans and instead divide them on a percentage method through a Qualified Domestic Relations Order (QDRO).

Understanding the difference between a defined contribution and a defined benefit plan is vital to equitably dividing retirement assets. Every defined contribution plan can be divided by simply assigning it a fixed value. Unless both parties insist, defined contribution plans should be divided on a percentage basis.