Home worth $500,000. No mortgage.
Husband’s 401k worth $750,000. Wife’s 403b worth $150,000. Non-retirement
investments also worth $120,000. Husband and Wife each have defined benefit
pension plans.
Income
Husband earns $110,000.
Wife earns $80,000
Wife’s
Proposal
Divorce is initiated by Wife. She seeks
no alimony. She establishes that she must retain ownership of the home
($500,000 asset) and that she will offset this $500,000 amount from Husband’s
401k of $750,000 leaving $250,000 that she says should be split in half thereby
asserting her claim to $125,000 of his 401k. She also says her 403b amount of
$150,000 should be split in half or $75,000 to each, and proposes to subtract this
$75,000 from the $125,000 that she is “owed” from his 401k. She also says that
she will retain her pension and Husband will retain his pension.
Reality
Derived from Valuations
The cost basis in the home is
$260,000. Therefore, if Wife retains ownership exclusively, her net equity will
be below the $250,000 taxable exclusion, making the house a tax-free asset for
her. In contrast, his 401k and her 403b are subject to full income tax rates. Conservatively,
we attributed a 25% tax rate to each, resulting in a net value of $563,000 and
$113,000 for his 401k and her 403b respectively. Analyzing the tax
ramifications for the different assets punctured a hole in Wife’s proposal.
With the tax analysis overlay, the home equity and the value of Husband’s 401k
were almost the same. She quickly backed down from asserting rights to his
401k.
The other part of the analysis that
punctured Wife’s proposal emerged from getting more data on each pension plan.
From each spouse’s plan administrator, we learned that in 8 years, she is
eligible for full retirement pension benefits of $3340/month, and that he was
eligible for $2200/month in that same year. Not only are the monthly
distribution amounts not equivalent, but additionally the life expectancy and
mortality rates are very different based on their ages and gender. In fact, the
net present value of her pension came to almost $800,000 where his came to
about $400,000.
Outcome
Although the parties were initially
diametrically opposed, and Husband felt that Wife’s proposal would have taken
him to the cleaners, as a result of the financial analysis, Husband will not
have to share any of his 401k, and other than a small stipend as an emergency
cash cushion for Wife, Husband will receive all non-retirement investments.
Each will retain his and her pension, and Wife will retain the house. Agreement
was reached because now Husband has adequate cash to make a down payment on a
home for himself. Under Wife’s proposal, he would have had to not only turn
over some of his 401k to her, but he would have also had to have borrowed from
the 401k in order to make a down payment.
Moral
of the Story
Although Wife’s proposal on its
face seemed very logical and reasonable, exposing the implications of both the
latent tax and pension valuations that were unknown to the parties facilitated
compromise and negotiation and a shift in the power play where each side got
enough of what was important to him and her to settle. Imagine how Husband or
Husband’s counsel would have felt had they failed to identify the rationale for
such valuations and their ultimate impact on the terms of the marital
settlement agreement.
This is a hypothetical
example and is not representative of any specific situation. Your results will
vary.
