Defined Contribution Plan

A "DC" plan is often referenced as a type of "pension" plan but, in fact, it is an ordinary account (invested in stocks, bonds or cash) that is (a) pre tax and (b) subject to distribution at a certain age or other event. Defined contribution plans would include IRAs, 401 (k) plans, 457 (b) accounts and others of this sort.

DC plans, when distributed, are subject to ordinary state and federal taxation. They are not subject to FICA or SE tax, in that this taxation has accrued prior to placement in the plan. As a general rule the plans, if not held to a certain age (usually 59 and ), are subject to a 10% penalty. However, at the time of the divorce transfers may be made between spouses with no penalty. This includes possible access to the cash via "roll out" and transfer of the funds. In other words, $ 20,000 in an IRA could be transferred from Spouse A to Spouse B, with Spouse B using/spending the funds, at no penalty. Of course, the transfer would be an ordinary taxable event for state and federal purposes.

It is often the case that DC plans are valued in the context of creating a property division between the divorcing parties. Local accountants (Joe Cunningham, Gary Rogow, Karen Sidney) have concluded that the appropriate value of a DC plan is the gross amount of the plan minus some estimate for taxes. The tax estimate, as always, contains some element of art and may be dependent upon the circumstances of the individual holder of the asset.

Of course, if there is a significant difference in perceived tax rates the parties can always QDRO the plan, resolving the issue. To the extent a default is appropriate I would suggest 20% as the present boilerplate choice. It seems more likely than not that at the time these plans will be accessed the individual will be retired or earning a nominal income, implying the present rate of 15% (federal) and 4.2% (state). These rates are declining but 20% still seems "about right" as an average of spillover choices, that is, where the income stream is placed over the possible spectrum of rates. In my experience with these plans (voluminous) I have never seen a discount rate higher than 30% for taxes. Most of the time, in Washtenaw County, 20% is used, and the (very) vast majority have fallen in the 20%-25% range.

See the entry on Section 72 (t), a way of avoiding penalties on defined contribution rollouts by use of a "functional" annuity or other periodic transfer.