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Actuarial Equivalence

Prior to negotiating or drafting a QDRO against a Defined Benefit Plan the practitioner should be familiar with 29 USCS 1056(d)(3)(D)(ii), which provides:

does not require the plan to provide increased benefits (determined on the basis of actuarial value),

This Practice Aid discusses “actuarial equivalence.” A workable definition of this term is: of equal value. Thus, two or more items are actuarially equivalent if they are of equal value. For example if the current worth of a Single Life Annuity payable monthly in the amount of $1,000.00 for a male age 65 is worth $130,000.00 and a Ten Year Certain Monthly Annuity in the amount of $900.00 for a male age 65 is worth $130,000.00 these two annuities are actuarially equivalent. The reader will note that actuarial equivalence does mean that the equivalent items are identical. The worth of the items will be identical, however, other features of each item will differ.

For QDRO negotiating and drafting purposes it is necessary for the practitioner to understand the application of the above cited prohibition.

Scenario One

Assume the husband retires with a monthly pension of $1,500.00. It is agreed that the wife is to receive one-third of this benefit. Clearly, one-third of $1,500.00 is $500.00. Does this mean that the wife will receive a monthly pension of $500.00? Absolutely not. Rather, the wife will receive the actuarial equivalent of a monthly pension of $500.00. In the vast majority of cases actuarial equivalence results in the Wife receiving less than $500.00. This reduction in benefit to the wife will be attributable to the fact that she has greater longevity than her former husband. Assume at the husband’s age 65 the wife’s age is 60. Using a standard actuarial table the life expectancy of a male age 65 is 15.7 years. For a female age 60 life expectancy is 23 years. Thus, the wife will be receiving monthly payments for 87.6 months after the death of the husband. She would receive $43,800.00 subsequent to the death of her former husband. An alternative method of expressing this greater stream of payments to the wife is to state that the cost to purchase her longer duration annuity is relatively greater than that of the husband. At a rate of 6% the cost to purchase the husbands annuity (of $500.00, which is the amount due to the wife) is $60,923.65. The cost to purchase a monthly annuity of $500.00 for the wife for her lifetime of 23 years is $74,755.49.

Clearly, these $500.00 monthly annuities are not of equal value: they are not actuarially equivalent. To make these two monthly annuities of $500.00 actuarially equivalent the cost of the wife’s annuity must be equal to that of the husband. Thus, the question becomes what amount of monthly benefit can be bought for the wife that has a cost of $60,923.65? Answer; a monthly annuity of $407.49. Thus, a monthly annuity of $1,000.00 to the husband and a monthly annuity of $407.49 to the wife, will under this fact pattern be actuarially equivalent to a monthly annuity of $1,500.00 paid to the husband.

To emphasize the need for clarity regarding Domestic Relations Orders and actuarial equivalence, consider a case in which a benefit is to be equally divided between spouses. The titled-spouse is the wife age 65 and the husband is also age 65. Assume the total monthly benefit payable to the wife $2,000.00. Thus, each expects $1,000.00. Using an interest rate of 6% and a standard mortality table, the wife will as expected receive a monthly benefit of $1,000.00. However, the husband will receive a monthly benefit of $1,118.10 (recall his shorter life expectancy). Thus, a monthly annuity of $1,000.00 to the wife and a monthly annuity of $1,118.10 to the husband is the actuarial equivalent of a monthly annuity of $2,000.00 paid to the wife.

Each of the above scenarios may result in a non-felicitous experience for an attorney. To avoid unexpected payout amounts and client outrage, be clear prior to crafting your settlement how 29 USCS 1056(d)(3)(D)(ii) will impact on your client. Request that your expert prepare an illustrated explanation of how actuarial equivalence will impact on the actual benefit paid to your client. Absent this exercise, consider how you would explain to the wife in scenario two, how one half of $2,000.00 is $1,118.10.