by David A. Thompson and Jerry Reiss
Defined benefit pension plans are very complex retirement plans. Obtaining a fair division of property for either divorc-ing spouse was never a simple matter. This task has been made more difficult and more complex following the Florida Supreme Court ruling of Boyett v. Boyett, 703 So. 2d 451 (Fla. 1998). This is espe-cially unwelcome news in these days because great efforts are made to settle cases and avoid the costly valuation process. Yet, many mistakes will be made, and either side could suffer an unjust division unless an inquiry is made of all the benefits that will be provided, and the conditions that attach to the receipt of those benefits. An actual valuation that determines the value of each benefit may be necessary for the parties to evaluate whether the division of special benefits warrant further inquiry or litigation.
Part I of this article will examine the principal problems that this ruling creates by the court’s use of a nonstandard definition of bene-fit earnings. It will also show that a coverture (or service) fraction may no longer be used to determine marital and nonmarital portions even if it is applied to the earned benefit on the cutoff date. Part II, which will appear in the March issue of The Florida Bar Journal, will examine why other states came to a conclusion opposite that of Boyett, as well as the little-known consequences of the ruling. One such consequence is that an employee can easily change a 50/50 court ordered division of property to a 75/25 split by merely delaying retirement for five years.
Defined benefit plans define and guarantee the employee a specific benefit at retirement. Most defined benefit plans define monthly benefits at some age, called retirement. The practitioner should be warned that not all defined benefit plans provide monthly benefits, and that certain defined contribution plans provide monthly benefits. The key to a defined benefit plan is that the benefit is guaranteed. With uncertainty sur-rounding whether the Social Security Administration will be able to meet its future obligation without additional cutbacks,1 errors in the division of benefits under the only other plans to provide commitments may not be tolerated by future clients.
Defined benefit plans serve many retirement plan purposes. As a guarantee of what will be provided at retirement, it offers the employee security that is simply not available under any defined contribution plan.2 It also guarantees employees who continue in the employ of the sponsor of the plan that their benefit earnings will be tied to the rising cost of living.3 This is accomplished by defining average earnings either as a career average or as the highest average over a three- or five-year period.4 As W-2 earnings will increase with any given employee over his or her working lifetime, the benefit earnings are tied to the rising cost of living.
Before the mid-seventies, many employers would pay retire-ment benefits only to employees who worked for the company their entire lifetime.5 This was often accomplished with capricious methods for measuring benefit earnings, lengthy cliff-vesting schedules,6 and bad boy clauses. The Employer Retirement Income Security Act of 1974 (ERISA) dramatically changed this by setting new standards that plans had to follow. The purpose of these changes was to make certain that the employer understood that promised benefits were equivalent to promised pay for work that the employee already performed. These rules were required to be observed if the employer intended to deduct (from corporate taxes) the cost of funding the plan as a necessary business expense.7 Among these rules was the requirement that benefits vest quickly. The employer could satisfy this requirement if the plan’s vesting conditions matched or exceeded any one of several different proposed formats.8 ERISA also prescribed several different methods under which benefits could be earned.9 Compe-tition over employees forced many municipal, state, and federal employers to strengthen their plans to match ERISA features.
The Boyett ruling equates the plan’s accrued benefit with the amount of retirement benefit that is earned on the cutoff date. People who have no experience with benefit administration matters fail to understand that accrued benefits are only a measure of what would be paid if the employees quit on the date of measurement. It is not a measure of what portion of the retirement benefits have been earned on that date if they contin-ue to work. It is only a minimum requirement of what the employ-er must pay if the employee fails to satisfy the conditions for retirement when they separate from service. Accordingly, accrued benefits are termination benefits and not earned retirement benefits. Termination benefits are defined in the plan as the accrued benefits that are earned before the participant satisfies the conditions for retirement. Actuaries, who are responsible under ERISA for funding these plans, must deal with this distinc-tion.10 Otherwise, the many safeguards that ERISA introduced to make certain that the employees received the promised benefits would be undermined by the employer’s inability to meet retire-ment benefit obligations when they fall due.
Many things distinguish retirement benefits from termination benefits. The first and foremost distinction is that vested termination benefits are received at a normal retirement date,11 whereas retirement benefits can be received at an earlier date, called the early retirement date, when certain age and service requirements have been satisfied at the date of separation.12 The amount payable may be reduced to reflect the extra number of years that it will be received by the employee.13 It also may be subsidized for earlier than normal retirement.14 This means that the benefit has greater value at the early retirement date.15 Subsidized benefits are extra benefits paid in addition to the termination benefit amount. There are also other subsidized benefits that may be paid, but only if the employee retires. These benefits could include the employer paying the full cost to provide spousal survivor rights. It might also include paying health benefits from the retirement plan.
A critical distinction between termination benefits and retirement benefits is that accrued benefits automatically vest upon satisfying the age and service requirements for retirement benefits, yet are subject to the plan’s vesting schedule when those conditions have not been met.16 Perhaps the most important distinction under family law is that the earned retirement bene-fit, which uses salary in its definition, was protected against the erosion of inflation to the date when benefits began, whereas the earned termination benefit was not. As retirement benefits are based upon a rule that considers salary earned over the entire working lifetime, and termination benefits are not, by focusing its attention on a perceived violation of the cutoff rule under F.S. §61.075(5)(b)(6), the Florida Supreme Court simply failed to divide retirement benefits, but instead divided termi-nation benefits.
Termination benefits are based upon a different definition of salary than retirement benefits and do not include rights to early retirement subsidies, survivor right subsidies, post-retirement health payments, or other ancillary benefits.17 As a result, the practitioner should be forewarned to take extra care in dividing these benefits and that certain forms of relief will need to be addressed before the parties enter into a mediat-ed or other settlement agreement.
Misconceptions about Benefit Earnings
A benefit that is earned includes an amount that is earned and a date when it can be paid. It also includes all forms under which the benefit may be received,18 as well as any ancillary benefits that may be earned after satisfying certain age and service requirements necessary for its receipt.19 In defining an accrued benefit, the date used never is determined by when the participant retires or some capricious date determined by employ-er discretion. If it were, the employer simply could defeat the ERISA mandate that earned benefits are promised pay for services already performed simply by firing the employee before the employee elects to retire. ERISA (and non-ERISA) plans solve this problem by defining earned benefits as benefits which may be paid at dates specified in the plan. ERISA also requires that all alternate forms of earned benefits be definitely determinable, by having the basis for the conversion also stated in the plan.20
Relationship to Alimony
As retirement benefits can be considered as an income stream or as property payment, but not both,21 when the employee-spouse paying alimony seeks modification of the amount at retirement, he or she can only exclude the amount of property that was actually divided at the divorce. Accordingly, proper measurement of benefit accruals is crucial to the determination process. If less than the full spousal share of marital benefits were paid under a mechanism defined by the court, then the full benefit was not divided. This especially occurs when early retirement subsi-dies are available, because the participant is often credited benefits after the cutoff date which could have been credited before by simply retiring. This problem can occur with benefits under all government plans because the spouse must wait to receive payment under a QDRO-like order until the employee retires.
When Boyett froze the earned benefit as to amount of monthly benefit that may be received, and when the employee also has control over the date that the nonemployee receives the frozen marital share of benefit, the ruling left only one method for dividing this property: By requiring the employee to pay the benefit while working.22 When the court fails to divide the property with this relief, the spouse does not receive the full frozen amount of the marital share, but some lesser amount. A calculation will be necessary to determine the lesser amount when the employee seeks modification of alimony at retirement.
Recalculation can be avoided by dividing the proper amount of benefit at the time of the divorce, by requiring the particip-ant to pay the spousal share of benefit while working. This method generally meets resistance from the employee on the ground that it forces that person to retire. This simply is not true. As the California Supreme Court noted In re Marriage of Gillmore, 629 P.2d 1 (Cal. 1981),23 if the participant is receiving $60,000 in salary, but instead could retire and receive $30,000 in retirement pay, that person is not working for the full salary of $60,000, but is working only for the difference, $30,000.24 Accordingly, it is not the court that removes the incentive to work, but rather the employer.
Can No Longer Use a Coverture Fraction
The principal issue before the Boyett court was whether a coverture fraction could be applied to a benefit at retirement in order to determine a marital share of that benefit. The court ruled that to do so violates the cutoff rule under F.S. §61.075(5)(b)(6), by factoring in salary that was earned after this date.25 The N.Y. Court of Appeals, faced with the same issue in Majauskas v. Majauskas, 463 N.E.2d 15 (N.Y. 1984), ruled that
by limiting the numerator to the number of months prior to commencement of the action during which the parties were married, the Appellate Division simply conformed the judgment to the statutory definition of marital property, as property acquired before commencement of the matrimonial action (Domestic Relations Law, §236, part B, subd. 1, par. c).26
As a consequence of the statute defining marital property, when the Boyett decision held that applying a fraction defined in DeLoach v. DeLoach, 590 So. 2d at 964 (Fla. 1st DCA 1991), violat-ed the cutoff rule by including nonmarital contributions into the marital component, it excluded post-marital contribution from the period that followed. This flows from the simple fact that F.S. §61.075(5)(b)(1) (which defines property excluded from divi-sion as premarital) and F.S. §61.075(5)(b)(7) (which defines property excluded as post-marital), together define the nonmarital portions of F.S. §61.075(5)(a)(4) property determined on the cutoff date.
Simply put, as this asset is not excluded in any one of the other provisions of F.S. §61.075(5)(b) as property not subject to equitable division during the marriage, what is not nonmarital property must be marital property. Accordingly, the “cutoff rule” defined under F.S. §61.075(5)(b)(6) doesn’t apply exclusively to a determination of a marital portion, be-cause the property is either defined under F.S. §61.075(5)(a)(4) as marital property, or under either F.S. §61.075(5)(b)(1) or (7) as nonmarital property. Therefore, any holding that a particu-lar valuation method overstates one of the two portions divided by the cutoff rule leads to a simultaneous finding that it under-states the other portion and, therefore, violates the cutoff rule under the same principle of law. In conclusion, when the frac-tion is applied to a benefit on the cutoff date, the Boyett ruling held that the product eroneously divides the earned bene-fit into marital and nonmarital components, by overstating the nonmarital portion that preceeds it by factoring salary increas-es earned during the marriage into the nonmarital portion.
Application of the Fraction before Boyett
As addressed in the 1996 Journal article,27 it never made sense to use the service fraction on the cutoff date when it preceeded the date of actual retirement, except to determine a marital portion of a present value interest. The reason that the service fraction should never be applied this way can best be illustrated by the following example:
Mr. and Mr. Smith, married for 20 years, divorce. The court awards Mrs. Smith 50 percent of his earned termination benefit of $1,200 per month ($600 per month). It was earned under a plan which accrues benefits at a rate of two percent per year, multipled by average salary, which was $3,000 per month on the cutoff date.
Three months after the divorce, the parties remarry each other. Mr. Smith works another 20 years. His average salary in-creases to $10,000 per month and he receives a benefit of $8,000 per month at retirement (40 years x 2% x $10,000/month). At retirement, he divorces Mrs. Smith a second time. She receives $1,975 per month for the second marriage (50% x $10,000/month x 2% x 19.75 years or 50% x 19.75/40 x $8,000 per month). Her total portion is $2,575/month ($600/month + $1,975/month), which supposedly represents half of his pension for all but three months of a 40-year earned benefit. His portion of the full $8,000/month benefit is what’s left, $5,425/month.
The huge difference between their respective amounts is the result of a misapplication of the fraction to the wrong benefit amount on the wrong date. It either should have been applied to the benefit at retirement or not used altogether.
Cart Before the Horse
The Boyett decision championed Trant v. Trant, 545 So. 2d 428 (Fla. 2d DCA 1989), in fashioning its ruling. Unfortunately, Trant provided specific guidance on the immediate offset method and not the deferred distribution method. Recalling that the main objective in defining accruals linked to salary was to protect the benefit from the erosion of inflationary forces, by awarding the spouse such increases under the immediate offset method, the spouse is provided the cost of living increases before they are needed. The spouse would then be free to invest those increases to produce more increases. This would create a double-dip of the same benefit.
Yet there would be no point in applying the coverture frac-tion to the present value amount on the cutoff date, as Trant does, unless the premise (or theory) to apply the fraction to the benefit at retirement already has been accepted.28 The Trant court did not calculate the actual earned increase tied to salary earned during each period, as was an issue that preoccupied the Boyett court.
Under the immediate offset method, as the spouse receives his or her share interest immediately, the application of the fraction to the present value amount (determined on the cutoff date) is consistent with the theory and logic which ap-plies it to the benefit paid at actual retirement under the deferred distribution method, because the spouse receives the payment entirely free of risk and on that date. It never made sense to apply the coverture fraction to the benefit at retire-ment even under the deferred distribution method when the spouse elects to receive benefits before then. The measurement process is stopped when the spouse elects to receive benefits. There-fore, its application to the benefit is made at the date of payment. Under an offset, that date is the cutoff date.
By applying the coverture fraction to the present value amount, as Trant does, is exactly equivalent to applying it to the benefit received at retirement, except that one must assume that the employee separates from service on the cutoff date, because the payment liquidating the property value is made on that date.
Ironically, had the court the benefit of the Boyett ruling before issuing its ruling in Trant, it should have come to the opposite conclusion: That the marital portion of the accrued benefit be determined as the increase of the accrued benefit measured on the cutoff date over the actual accrued benefit determined on the date of marriage, and that this difference is then commuted to a present value amount.
1 Benefits were already cut back once. See 42 U.S.C.A. §416(l)(1) (West Supp. 1998).
2 McGill, Fundamentals of Private Pensions 101 (4th Ed. 1979).
3 This is different from post-retirement cost of living adjust-ments. Post-retirement cost of living adjustments can be provid-ed in private plans by tying these increases to the investment performance of the plan. Some government plans provide post-retirement increases in the same way. Most provide a fixed per-centage increase or some percentage guarantee of the consumer price index.
4 McGill, Fundamentals of Private Pensions ch. 5 (4th Ed. 1979).
6 Cliff-vesting is defined as zero percent vesting for a specified number of years and then full 100 percent vesting thereafter.
7 I.R.C. §401(a).
8 29 U.S.C.A. §§1053(a), 1054 (West Supp. 1998)
10 See Treas. Reg. §1.412(c)(3)–1(c)(4)(i). Also see McGill, Fundamentals of Private Pension Plans chs. 15–21 (4th Ed. 1979).
11 29 U.S.C. §§1054 (West. Supp 1998).
12 See McGill, Fundamentals of Private Pension Plan 116–117 (4th Ed. 1979).
13 Id at 117.
16 Id. at 116 and 139.
17 Post-retirement benefits, while paid only at retirement, are generally not considered retirement benefits under ERISA. They were originally defined as welfare benefits and continue to be recognized as such, because they are designed not to vest and an employer was free to terminate them at any time. Recent federal case law has changed this concept because many employers were offering these benefits as inducements to retire, or in lieu of other retirement benefits, and the employees were given the understanding that these benefits would not be terminated. For a complete explanation of the topic, see Reiss and Walsh, Post-Retirement Medical Benefits: A Not-So-Certain Property Right, 15 AAML J. 2 pp. 375-390 (1998).
18 26 U.S.C.A. §§411 (d)(6)(B) (West Supp. 1998).
20 26 U.S.C.A. §401(a)(25) (West Supp. 1998).
21 Diffenderfer v. Diffenderfer, 490 So. 2d at 267 (Fla. 1986).
22 Koelsch v. Koelsch, 713 P.2d 1234 (Ariz. 1986)
23 See footnote 7 of that opinion.
25 Boyett v. Boyett, 703 So. 2d at 452.
26 Majauskas, 463 N.E.2d at p. 22.
27 Reiss and Reynolds, The Not-So-Simple Coverture Fraction: When Do Attorneys Risk More Than Embittered Clients?, 70 Fla. B.J. 62 (May 1996) and 70 Fla. B.J. 101 (June 1996).
28 See a discussion of the marital foundation theory in part I of The Not So-Simple-Coverture Fraction: Do Attorneys Risk More Than Embittered Clients?, 70 Fla. B.J. 64–65 (May 1996).
With offices in DeLand and Clearwater, Jerry Reiss is certi-fied by the Society of Actuaries and licensed by the DOL and IRS. He is a nationally recognized author on the subject of valua-tions. Previously articles appeared in both the Trial Lawyers and Family Law section columns of The Florida Bar Journal.
David Thompson received his law degree from Syracuse University and received a master of laws, taxation, degree from Temple University and works in the life and health insurance industry.
This column is submitted on behalf of the Family Law Section, Jeffrey P. Wasserman, chair, and David L. Manz and Susan Chopin, editors.