By Robert Parker, CPA, MBA, Senior Accountant
Melvin and Maureen Collins were married for thirty-five years. In 2005, the couple separated and subsequently divorced. Melvin, who was the sole breadwinner, has been employed as a professor of economics at a prestigious Orange County university. During their marriage, Maureen was a stay-at-home mom. Their divorce settlement included a monthly spousal support award to Maureen of $7,500, which Melvin paid to her through 2015.
Although Melvin recently turned 66 and could retire, he has remained in his position at the university. Including salary, frequent lectures throughout the USA and abroad, and several books he has authored for which he receives royalties, he continues to earn nearly $39,000 per month. His non-university income represents considerably more than half his total earnings.
Maureen, who is now 69, learned of Melvin’s potential retirement and proposed continued spousal support of $7,500 per month for five additional years. This request would be in addition to the split of Melvin’s retirement account worth $4,000,000, which had been ruled community property per their divorce settlement agreement. Thus, Maureen was going to receive $2,000,000 soon. The matter in question was whether Maureen required the additional five years of spousal support to maintain her standard of living given she already was to receive half of Melvin’s retirement account. The total amount in question for the additional spousal support was $450,000.
Why We Were Hired
Should Melvin decide to retire, his annual earnings would significantly drop. Thus, he wanted to reduce or eliminate the amount of Maureen’s request so he could maintain his lifestyle through this five-year period regardless of whether he continued teaching. Melvin’s attorney agreed. Thus, they hired our firm to determine whether the amount of Maureen’s request could be reduced and, if so, by how much.
To achieve this goal, our initial step was to analyze the marital standard of living at the date of separation. We needed to ascertain when the retirement account would cap out at maximum support and, based on this, calculate what the retirement plan’s annual distribution would be to Maureen.
According to the Department of Social Security’s life expectancy calculator, the assumption was Maureen would live to age 86. She wanted her $2,000,000 portion of Melvin’s retirement plan to continue up to her life expectancy. (The value of half the retirement accountant at the date of the expected initiation of distribution was calculated at $2,096,226).
There are two acceptable approaches to determining cash flow. One is based on the required minimum distribution (RMD), which is an algebraic formula based on age, health and asset balance. The other alternative is fixed withdrawal (FW). As of December 31, 2015, the Moody’s AAA bond rate was 4.04% and the 20-year S&P compound annual growth rate was 9.44%. To be conservative, we used a 5% growth rate.
RMD: We spread the required minimum distribution for seventeen years (age 69 to 86). The RMD base amount would begin at $75,474 for the initial year and then, on a gradient, increase each year to $139,052 for the final year. Based on the 5% annual growth rate, the ending balance of the account would stand at $1,810,455.
FW: Using the fixed withdrawal method, the balance at the end of the 17-year period would drop to near zero. However, the fixed annual withdrawal for each of the 17 years would be $168,950 based on the 5% expected annual growth rate.
We expect that the opposing counsel will want to know if living 17 years using the fixed withdrawal method ($168,950 withdrawal per year) would be enough for Maureen to maintain her marital standard of living in today’s dollars (the amount would be adjusted to inflation based on the expectations of a long-term marriage).
If Maureen were to support herself based on the required minimum distribution and spousal support, her husband would be required to make spousal support payments of $7,500 per month for up to five additional years, as long as he remained employed. However, if Melvin were to retire from the university within five years, Maureen would cease receiving spousal support and have to sustain herself on approximately $6,600 per month, with about a $300 to $400 increase per year. This would initially be around an 11% reduction in monthly income. Will she be willing to take the chance he will not retire?