Because of California’s community property laws, many people believe the process of dividing marital property will be simple and straightforward. After all, the law generally splits these assets equally. So couples often assume that they will not need to expend much effort or thought on the process of dividing marital assets.
However, this assumption fails to take account of the fact that the process of classifying property as marital or separate can be complicated and contentious. Moreover, once they have determined the portion of assets that will be treated as marital, the logistics involved in dividing those assets are often complex and filled with regulatory requirements.
Dividing retirement benefits is one of the most complicated tasks in asset division in California. Because these assets usually represent a significant portion of a couple’s property and the assets have significant emotional value and such a tremendous impact on the future, the process of dividing retirement benefits can cause painful conflict and lead to dissatisfaction. The more you know about the process going in, the better prepared you will be to move forward with the right plan for the future.
Community Property Laws
It is well-known that California is a community property state when it comes to divorce. However, many people misunderstand the meaning of the term. They also forget that federal law often comes into play and that federal law overrides state laws.
In general terms, California community property laws specify that assets and debts acquired between the start date of marriage to the date of separation will be divided equally upon divorce. This is true even if it is property earned through only one spouse’s employment. But as with every general rule, there are exceptions.
Pensions are Complicated in Divorce
In many high-asset California divorces, employment compensation packages and retirement benefits form one of if not the most valuable set of assets at issue in the division of property. An employee may receive many types of benefits that could all potentially be treated as marital property, and pensions are among the most complicated to value and divide in divorce.
Pension benefits are a form of deferred compensation for services rendered during a spouse’s employment, or credits towards future income, to put it more simply. The employment contract will determine when an employee begins to earn those credits. Some employees start to start credit right at the start of employment while others must work a certain period to start accruing credits. The employee may earn credits but not have the right to take them until they become fully vested in the program. This could be a gradual process.
Pensions are different from an IRA or 401(K) plan or other defined contribution plan. In those types of plans, money contributed to the account by the employer or employee can be immediately accessed for borrowing or early withdrawal. With a pension, there is no money in an account. The monthly payments are based on the credits earned and are distributed upon retirement. They are often referred to as defined benefit plans in contrast with the defined contribution plans.
Courts have held that if the right to a retirement benefit accrues at least in part during the marriage (i.e. before separation,) then that benefit is community property and both spouses own an interest in it. The service that earned the benefit was provided during the marriage, thus earning the benefit during the marriage even though will not be paid out until years later.
Social Security Benefits are Governed by Federal Law
Like pension benefits, Social Security retirement and disability benefits are earned through work credit over time and paid out later as periodic payments when an employee reaches retirement age. However, these benefits are subject to federal law rather than California law. Federal law treats Social Security retirement benefits and disability benefits as an employee’s separate property rather than marital property. Social Security benefits are not transferable, nor can they be assigned by the wage earner. A divorcing spouse has no interest in the other spouse’s Social Security benefits.
However, the federal government will allow a divorced spouse to claim derivative benefits if:
- The spouse who earned the benefits is eligible to claim retirement or disability benefits
- The marriage lasted at least 10 years
- The divorced spouse claiming benefits has not remarried
- The divorced spouse claiming benefits is at least 62-years-old
- The benefits the divorced spouse would receive based on their own work history are less than what they would receive through their derivative rights
If a worker’s former spouse receives benefits based on their work history, that will not reduce or in any way impact the benefits that the worker—or the worker’s new spouse—is eligible to receive. Both current and former spouses can receive derivative benefits equal to up to 50% of the worker’s benefit amount.
An Example Showing How Retirement Benefits Can Create an Imbalance in a Divorce
In the landmark case In re Marriage of Peterson, the California Supreme Court ruled that courts must divide community property according to state law and therefore split a wife’s pension even though they could not divide the husband’s social security. The court did note that the parties could have reached their own agreement that would have provided a more equitable outcome, so divorcing spouses need to be aware of any potential inequalities under the law and prepare to negotiate appropriately to protect their interests.
In the Peterson divorce, the difference between the state laws governing pensions and federal laws governing Social Security resulted in an imbalance against Annette Peterson. As a Deputy District Attorney for the county of Los Angeles, Annette was prohibited from contributing to Social Security because, as a county employee, she was a member of the Los Angeles County Employees Retirement Association (LACERA) Plan E, a defined-benefit retirement plan that paid a pension similar to Social Security.
In the LACERA plans, contributions came from the employer rather than the employees. So instead of contributing to Social Security, Annette kept her income and her employer contributed to her LACERA plan. The amount of benefits paid under the LACERA plan was based on the member’s age at retirement, amount of service credits earned, and the amount of final compensation.
At the time of the divorce, Annette had accumulated more than 14 years of service credits with a value estimated between $200,000 and $216,000. (Because the value is based on the estimate of what would be paid out during her retirement years, the value could not be established exactly because there was no way to predict how long she would remain alive collecting benefits.)
Based on Social Security calculations, the value of John’s Social Security benefits totaled $228,000. Annette argued that the laws governing LACERA pensions and the laws governing Social Security created an imbalance because while the spouses would split her retirement benefits evenly, her husband would receive all of his Social Security retirement benefits and she would receive none. She argued that this gave him 150% of the retirement benefits in the marriage and left her with only 50%.
The trial court ruled in the husband’s favor, so Annette asked the California Supreme Court to correct the imbalance. She suggested several options for creating an equitable solution, including awarding John less than 50% of her LACERA benefits. The Supreme Court affirmed the trial court’s ruling, citing the requirement under California law that community assets be divided equally in a divorce. Since Social Security is separate rather than community property, the court held it could not be divided but that the court was bound to divide property legally considered community property even though it created an unequal division overall.
The Supreme Court then reminded the parties that they were free to develop a more equitable solution not based on strict application of the law which the Court was bound to uphold.
Although since this ruling there have been some adjustments made to the laws to limit this type of imbalance in divorce, spouses and their attorneys need to be aware of the potential for inequitable results so they can strategize accordingly. Depending on the amounts paid into Social Security and the amount of the pension benefit, even with these adjustments, the Peterson case would have resulted in a similar outcome.
Keep the Balance in Mind When You Address Retirement Benefits in a California Divorce
Working with an experienced and savvy divorce attorney or family law mediator in California offers you an opportunity to create balance when the law does not. Both spouses lose when a case becomes contentious--even the spouse who appears to come out ahead in an equitable pension arrangement, as the husband appeared to do in the Peterson case.
Here’s why. The Petersons separated on February 17, 2010 and filed for divorce around that time. They agreed on all aspects of their divorce, including custody, child support, and the division of their other assets and debts. They could have resolved the divorce terms very quickly were it not for the disagreement over the division of the pension.
The issue was tried at the Superior Court (county level) and then appealed to the California Supreme Court. That Supreme Court Ruling was filed January 11, 2016. The Petersons endured nearly six years of uncertainty, court battles, and legal fees.
Because their case had to be tried, not once, but twice because of the appeal, the spouses probably spent well over $50,000 each in legal fees, in addition to other expenses. They had to deal with the stress of a court battle for nearly six years. Was it worth it?
Finding efficient solutions is often more valuable than the costs of fighting for what you feel is right and taking the gamble that it will all be worth it in the end, especially when there are children or grandchildren involved. Often, couples have enough resources to share, particularly in a high-net-worth divorce. The struggle emerges when the emotions or the law create a sense of unfairness.
No one should want to spend $100,000 or more on a divorce, but conflict can drag a case out, sometimes over retirement assets or other property worth less than the legal fees.
Fighting for “legal entitlements” and “the principle of the situation” can make any divorce more damaging than it needs to be. Limiting those damages by working towards a “win-win” agreement can have future rewards in the form of a faster divorce recovery for co-parents, other affected family members, business partners, and even future relationships. Mediation, negotiation, or the collaborative divorce process can help parties develop a cost-effective solution that divides retirement assets quickly and fairly.
Special Handling for Retirement Plans
While retirement assets in 401(k) and similar plans may be easier to value than pension plans, these assets still require special handling during a divorce and parties must be aware of potential tax consequences to keep the division equitable. Often these plans are funded with earnings contribution prior to taxation, so the tax will need to be paid when funds are distributed. The tax liability can be further deferred if the assets are handled properly but if not, one or both spouses could face a substantial tax bill after the divorce.
In addition, it is often necessary to prepare a qualified domestic relations order or QDRO in order to obtain a distribution from a retirement plan. This is a judicial order that is usually drafted by a team with specialized experience and presented to the court for approval. The QDRO will include the terms of the division that is part of the divorce so that the retirement plan administrators will be authorized to distribute funds to someone other than the employee who earned the benefits. The process of obtaining the distribution can take considerable time. Afterward, the spouse receiving the distribution may need to have a plan to roll over all or part of the funds to avoid paying taxes on those funds immediately.
Because of the complexity in distribution and the potential tax issues, it is important to work with a divorce attorney who can provide the advice and assistance you need to avoid delays, penalties, and problems.
Holstrom, Block & Parke Protects Your Interest in Retirement Benefits in a California Divorce
The bottom line is that even with the “50/50” community property division laws in California, the process of dividing assets can be very complicated, and you can be stuck with an inequitable result if you are not careful. Advice and representation from an experienced divorce attorney can make all the difference both during and after the divorce process.
At Holstrom, Block & Parke, APLC, our Certified Family Law Specialists and associates have over 300 years of collective experience helping clients reach the best outcomes in divorce and other family law challenges. Schedule a consultation with our team today to learn how we can protect your interests in retirement benefits and other aspects of your divorce.
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