Determining the Nonmarital Portion of Pensions and Retirement Benefits
An earlier article bearing a similar title1 examined the operating principles needed to determine the nonmarital portion of real estate property, securities, and closely held businesses, and it touched upon retirement plans. This article will deal with some of the more complex issues affecting retirement plans. Due to the intricacies and complex nature of many retirement plans, they are often misunderstood, leading to misapplication of statutes and case law interpreting them.
Defined Contribution Plans
A defined contribution plan delineates the amount of contribution made in any given year or during any given period in which the contribution is made. These plans include 401(k) plans, profit sharing plans, 403(b) annuities and other money purchase pension plans, target benefit plans, thrift and other savings plans, and ESOPs. While these are not inclusive of all such plans, they do cover the vast majority.
The most important issue in determining the nonmarital portion of a defined contribution plan is to understand how this should be accomplished. Nonmarital portions are often apportioned on the basis of tracing investments when the participants have some control over them, such as with 401(k) plans; and when they do not, the portions are often determined with service fractions. Each scenario merits discussion because both methods violate Florida Statutes.
When tracing investments is used as a method of nonmarital asset valuation, the reasoning is often that unless the investments can be traced, a nonmarital portion cannot be established because it is the participant’s burden to establish a nonmarital portion.2 This reasoning confuses the usual burden to show a nonmarital portion of an asset from the burden of overcoming a presumptive gift under F.S. §61.075(7), where tracing investments demonstrate intent. The participant never owns investments of a retirement plan; the plan trust does. The participant only has rights to perquisites under the trust agreement. As such, the interest that any one employee has in these perquisites is a specific right to benefits earned under this one single trust. As the securities are owned by the trust, each employee derives a right to a specific amount of money from a single fungible composite trust fund.
Mutual funds have been determining interests under this mechanism for decades, and thousands of shareholder interests are accurately determined to the penny even though all investors collectively share interests in one composite fungible fund. Tracing investments is unrelated to whether a nonmarital portion can be established. It is only needed when a presumptive gift is raised in connection with titling the asset where both spouses can exercise equal control over that asset.
The difficulty with using a service fraction to determine the nonmarital portion is that its use divides nonmarital and marital periods into equal yearly accruals. These accruals are often based upon salaries that are earned each year and are almost always based upon circumstances unique to that year. ESOPs, 401(k) plans, and other profit sharing plans involve employer (and employee) discretion on the amount of contribution additions. In some years, plan contributions will be made; in others, they will not. Contributions for some years will be higher than others, and the amount of salary paid need not have anything to do with the contribution amount. Finally, even when all of the criteria for determining the yearly contribution amount previously mentioned are conspicuously absent, investment returns improving the annual contributions vary widely from year to year. Use of a service fraction credits certain years following 1999 with a very high rate of return even though the earnings for many of those years may have been negative. This is also why service fractions should not be used.
Only one method can be properly used to determine the nonmarital interest: the participant’s account balance on the date of marriage, improved by investment earnings to the cutoff date. The correct method is seldom used because it is tedious, complicated, and often expensive to perform. But doing the calculation incorrectly can produce huge errors. The nonmarital portion is commingled with marital contributions and investment earnings, which are a composite of earnings on nonmarital and marital investments. As discussed earlier, this is only a technical issue and is easily overcome. While there may be numerous ways to determine a commingled rate of return, they do not include tracing investments or a service fraction. The earlier Bar Journal article bearing a similar title suggested the dollar-weighted method as perhaps the most accurate way to determine the rate of return. It is also the most widely used method by economists and investment firms.
Defined Benefit Plans/Boyett Concerns
This section begins with revisiting one of the issues addressed in our February 2001 article, “Dividing Pension Property After Boyett,”3 because the Boyett v. Boyett, 703 So. 2d 451 (Fla. 1998),ruling continues to be misinterpreted. That article addressed two theories invariably used throughout the country in determining a marital interest: a) the bright line theory; and b) the marital foundation theory.
Under the bright line theory, the measurement of what was earned during the marriage first calculates what was earned on the date of marriage utilizing service and salary through that date. This amount is then subtracted from the amount earned on the cutoff date, utilizing service and salary on the later date. The method is referred to as a bright line because it simply measures the improvement during the marriage over what would be paid to the employee on each respective date without taking into account a discount for vesting. Theoretically, the concept is easy to explain and to apply. For the bright line theory to apply, the state law governing marital earnings would need to ignore the distinction between passive earnings accruing on nonmarital property and active earnings (involving active effort) on nonmarital property. There are a few states that do define marital property to include all earnings. Florida is not one of them.4
The marital foundation theory rejects the idea that earnings can easily be determined on the date of marriage. What was earned varies by when the employee retires. Many benefits are determined by eligibility requirements that often cannot be met by excluding the marital service. Benefits also are determined with salary earned at retirement and are built on a foundation of efforts. The later salary requires the experience acquired during the marriage. Conversely, when nonmarital years occur before the marriage began, it too forms the foundation for the higher earnings paid during the marriage. As neither portion can be supported without the other in determining what will be paid at retirement, all accruals made during the preretirement years, whether before or during the marriage, equally contribute to the final retirement benefit result. Hence, both the marital and nonmarital portion can be determined with a service fraction. When a service fraction is applied to a benefit earned on the cutoff date, the marital foundation theory is used. It treats the earlier nonmarital period as the earlier foundation, thereby giving all yearly earnings equal weight.
When the Florida Supreme Court ruled that one cannot use salary earned after the cutoff date in determining a benefit accrued during the marriage, it embraced the bright line theory.
This bright line theory must be used for all benefit calculations that utilize salary for more than just consistency’s sake. As the appellate courts have consistently held that marital property includes passive increases until the date paid,5 when the Boyett Supreme Court ruled that earning the higher salary after the cutoff date is not included in the marital benefit, it effectively found that earning that higher salary involved active effort. When that higher salary instead is earned during the marriage, the active effort of the employee generates marital property by improving the nonmarital service accruals under F.S. §61.075(5)(a)(2).6 Accordingly, a service fraction should not be applied to a benefit earned on the cutoff date because it results in the earlier pre-marital accruals having equal weight with the marital accruals, even though a significant portion of that measured premarital benefit was actively earned during the marriage. Therefore, the Florida Supreme Court adopted the bright line theory for distinguishing accruals based on salary earned.
Use of a service fraction embraces the marital foundation theory. As such, it should seldom be used, except perhaps when it is impossible to determine an accrued benefit earned on the date of marriage because either the plan administrator failed to maintain records for that date or the information needed to do a benefit calculation is unavailable. The participant should not be penalized for failing to demonstrate a nonmarital portion when the information needed is simply not available.7
There should seldom be a reason to allow its use when the information needed is available, because the vast majority of pension property is owned by male participants, and allowing indiscriminate use of two separate theories — one always applied to the measurement when there is nonmarital service and the other applied when there is not — always produces results to favor the participant and penalizes the nonemployee spouse.
When a Retirement Plan Pays Disability Benefits
This may not be the most frequent issue affecting the amount of nonmarital property, but it is almost always applied incorrectly, and the impact of the incorrect application can be devastating to the other spouse. Everyone recognizes that insured disability benefits are probably not marital property, but when a retirement plan pays benefits on account of a disability, these benefits are often automatically classified as disability benefits with no thought given to whether this classification is correct. The result of the error compounds when the principles of Weisfeld v. Weisfeld, 545 So. 2d 1341 (Fla. 1989), are applied incorrectly.8
There are two critical factors that distinguish retirement benefits from disability benefits: 1) plans paying retirement benefits contain definitions that describe both when a benefit is earned and how much is earned (29 U.S.C. §§1052, 1054); disability benefits, which are defined by 29 U.S.C. §1002(1) as a welfare benefit plan, do not (29 U.S.C. §§1051(1), 1053) and 2) plans paying retirement benefits must contain a definition of when the benefit vests (29 U.S.C. §1053); disability benefits never vest.9 Once a retirement benefit is earned, it cannot be reduced by the employer.10 When a retirement plan pays benefits as a result of a disability, whatever retirement benefits have been earned on the date of disability automatically vest under the plan even if the participant lacked the necessary age and service required for an early or normal retirement.11 Accordingly, the premise that all disability benefits are nonmarital is incorrect.
Like all welfare benefits, disability benefits are only paid when certain conditions that randomly occur in nature are met. That is why insurance products are often used to finance this uncertain employer obligation. But when the disability is permanent and prevents that person from returning to work, a retirement results. This is the reason why many retirement plans pay disability benefits. The disability benefits of the permanently disabled are paid by the retirement plan, and it is either funded with insurance contracts or it is self-funded with employer contributions. Either way, the portion that replaces the wages of the preretirement years is a separate insurance component within the retirement trust. The benefit that had been earned prior to the date of disability is still a retirement benefit and has absolutely nothing to do with the Weisfeld ruling. Once the retirement benefit has been identified, Weisfeld is then applied to the insured disability portion to determine what portion of that benefit may be marital property.
There is often a Weisfeld component of the insured portion of the retirement plan and very often it can be significant. The Weisfeld property component is often created when extra service credits are used to determine the amount of payment under the retirement plan. When the extra payment is paid during the normal years of retirement, these extra benefits replace future wages in the same way that all retirement benefits do. Therefore, the Weisfeld component is the extra retirement benefit that results from the insurance portion of the retirement plan. They may be considered marital property to the extent that the proceeds of the disability entitlement occurred during the marriage. The extra benefits paid before the normal retirement date12 are clearly enhanced disability benefits not subject to equitable distribution.
Executive Stock Options: Marital or Nonmarital?
Executive stock options involve the ability to purchase a stated amount of company stock at a very favorable price. The time period to make the election is provided with the award and the favorable price is referred to as a strike price. The executive stock option is a form of compensation in the same way that retirement plans are, except it does not fit within the definition of a retirement plan because the benefits become available at a time unrelated to retirement or termination of employment. It is certainly a deferred compensation program to the extent that unvested shares require future work effort for them to vest. That by itself has been confused by many to suggest that the compensation is made for future work effort because all retirement plans have vesting requirements, but an unvested accrued retirement benefit has always been recognized as compensation for past services.
There are many reasons why unvested retirement plan accruals represent payment for past service apart from the 1988 statutes defining them as such in F.S. §61.075(5)(a)(4). One reason is that these retirement benefits automatically vest on death, disability, plan termination, or when massive amounts of employees terminate employment, such as occurs with a closing of a division or a plant. Retirement benefits also vest upon reaching an early or normal retirement age as defined in the plan.
The first ruling to analyze stock options in Florida is Jensen v. Jensen, 824 So. 2d 315 (Fla. 1st DCA, 2002). The court understood that when stock options are awarded on a yearly basis, there must be a component of the award that is made for past service, otherwise the award would not have been made if the prior awards were not justified by the performance that followed. It is also understood that when an employer directs that these awards vest on disability and death, the options themselves work as compensation entirely for past service and vesting then works only as a “golden handcuff” and nothing more. When an employer does not intend to make the stock option as compensation for past service, it will not have these options automatically vest on death or disability, as many awards do not. Jensen was correct with this finding.
Another consideration not mentioned by Jensen is what happens on a merger/acquisition of the company. This information can either be found in the conditions required for vesting stated in the award itself or in the contract of employment between the employer and the executive. If the award fails to vest, it speaks nothing to intent, because many executive contracts require employees to work past the sale of the business in order to make the company more salable. But when the options automatically vest on a merger/acquisition, it speaks volumes as to the employer’s intent that the award of these options is for past service, because vesting works against the company’s interest to make the company more salable. The finding in Jensen that these options are a form of deferred compensation covered in F.S. §61.075(5)(4) is circular reasoning because, while they are deferred, it does not necessarily fit within the meaning attached to deferred compensation programs. Deferred compensation programs defer the compensation on wages already earned. This has yet to be established and cannot support the conclusion that it has been earned.
Two subsequent rulings emanating from of the Second District Court of Appeal13 are troublesome because in each, the employer’s intent on whether the options are awarded for past or future service is determined by testimony from the employer-witness, which should be scrutinized for bias. If vesting truly was designed solely as a handcuff encouraging the employee to remain employed, the plan design is undermined if the nonemployee spouse receives half of the future vesting as equitable distribution. Jensen ably demonstrated that employer intent could easily be determined by the way the options work. This could be established with expert witness testimony instead of testimony of a company officer who often has a vested interest in the outcome of the divorce.
Federal courts make these types of determinations based on how the plans read and what additional written information has been published by the employer and given to employees. Federal courts also examine how the employer interpreted employee rights based upon criteria not mentioned in the employer literature. If rights to employee benefits were determined with testimony on employer intent, employees would seldom be able to enforce their rights, because employers could always be expected to testify in their best interests.
The Drop Plan
DROP refers to the deferred retirement option program. This plan allows the employee to work when he or she could retire without penalty for early retirement and not forfeit retirement benefits that would be paid only with an actual retirement. DROP can be viewed as nothing more than an extra paycheck for working the DROP years. Electing this option requires actual retirement at the end of the DROP period; however, the employee receives no additional retirement benefits than he or she would have otherwise received had he or she retired on the date DROP was elected. The government sponsoring DROP portrays it as an additional incentive to retire, but that only masks the real intent behind it — to discourage retirement by giving employees a substantial pay increase for working the DROP years, and it does so without voter approval. The substantial pay increase is the receipt of retirement benefits that were forfeited in the basic retirement plan when an employee continues to work. Simultaneous receipt of benefits with W-2 pay is defined in the case law as double dipping.
Recent decisions relating to DROP benefits14 fail to consider that DROP is a separate plan that has received qualified plan status by the IRS. Not only is DROP a separate plan, but it works as a completely different plan and unrelated to the basic plan to provide a monthly pension. Retirement plans require an actual retirement for benefit eligibility. This plan requires working the DROP years for benefit eligibility. While the payments are the same irrespective of whether the person retired, the payments are not functionally equivalent, as some rulings have held. As with any retirement plan and as with the original plan before DROP was added, no payment is made for any month that the employee works and the payment that the employee would have received is lost. Therefore, the payment before DROP was added is zero. This is not the equivalent of the DROP payment. Furthermore, as the DROP payment accrues for each month worked and is vested on death or disability, if anything, DROP functions as a defined contribution plan with the amount of the contribution being the monthly DROP benefit. The accrual under the DROP defined contribution plan is made only if the person works in a given month and the amount accrued is equal to the number of months worked.
Based upon the foregoing, it is inappropriate to determine a nonmarital portion of a retirement plan by tracing investments. A methodology based on a service fraction is also inappropriate and should not be used. When the issue of a nonmarital portion shifts to defined benefit plans, the trial courts have overlooked the impact of the Boyett ruling and how selective use of a service fraction conflicts with the ruling. The problem is compounded because a great many defined benefit plans have recently changed to cash balance defined benefit plans, and these are being confused with defined contribution plans.
Additionally, all disability retirement benefits contain pure retirement benefits, as we showed when the earned retirement benefit is enhanced with a Weisfeld component.
The employer’s intent in awarding stock options can be determined by analyzing the contract awarding the options. Allowing the employee to introduce evidence on employer intent permits the executive to introduce bias into the outcome. It can easily be inferred that all employee benefits are designed to retain the workers. This has no bearing on whether the full benefit was earned on the date of the award. The frequency of the award can be compared with the vesting period in order to determine whether vesting works to allocate earnings to a specific time period worked. When a company provides the employee with immediate vesting on death or disability, this is substantial and competent evidence that the benefit was earned on the date that it was awarded and that vesting works no differently for it than it does with retirement benefits.
Finally, executive stock options are often deferred bonus awards. They are often marital property under F.S. §61.075(5)(a)(4) when they work this way, regardless of whether they are fully vested. The burden then shifts to the employee to show that they are not marital property, or that some portion of them may not be. It is not sufficient to show that the benefit works as a golden handcuff. The purpose of all employee benefits is retention of employees.
1 Miller & Reiss, Determining the Nonmarital Portion of Retirement Benefits and Other Property, 81 Fla. B. J. 34 (Feb. 2007).
2 Jahnke v. Jahnke, 804 So. 2d 513 (Fla. 3d D.C.A. 2001).
3 Reiss and Thompson, Dividing Pension Property After Boyett, 75 Fla. B. J. 47 (Feb. 2001).
5 Soterakis v. Soterakis, 913 So. 2d 688 (Fla. 5th D.C.A. 2005).
6 Carollo v. Carollo, 920 So. 2d 16 (Fla. 3d D.C.A. 2004).
7 Pennsylvania issued a Boyett-type ruling in Katzenberger v. Katzenberger, 633 A.2d 602 (Pa. 1993), adopting this precise reasoning. It was later defeated by legislation. See also Paulone v. Paulone, 649 A.2d 691 (Pa. Super. 1994).
8 Rumler v. Rumler, 932 So. 2d 1165 (Fla. 2d D.C.A. 2006); Gafney v. Gafney, 965 So. 2d 1217 (Fla. 4th D.C.A. 2007).
9 29 U.S.C. §1051(1); see also In re White Farm Equipment Co., 788 F.2d 1186 (6th Cir. 1986).
10 See 29 U.S.C. §§1053(c) and 1054(g) for ERISA plans and for government plans within the state of Florida, Fla. Stat. §121.011(3)(d). See also Florida Sheriff’s Assoc.v. Dept. of Admin., Div. of Retirement, 408 So. 2d 1033 (Fla. 1982); and Branca v. City of Miramar, 634 So. 2d 604 (Fla. 1994).
11 This result is achieved because no benefit which has not both vested and matured may be paid from a trust. If the employer did not want to pay benefits on account of disability, it would not offer a disability retirement option in the plan.
12 The normal retirement date is a term defined in the plan and is customarily age 65. In high-risk plans, such as plans for firefighters and police, that date can be as early as age 40.
13 Ruberg v. Ruberg, 858 So. 2d 1147 (Fla. 2nd D.C.A. 2003); Parry v. Parry, 933 So. 2d 9 (Fla. 2d D.C.A. 2006).
14 Russell v. Russell, 922 So. 1097 (Fla. 4th D.C.A. 2006); Pullo v. Pullo, 926 So. 2d 448 (Fla. 1st D.C.A. 2007).
Jerry Reiss was originally licensed by the DOL (and IRS) to do valuation work under ERISA, by the SOA ASA designation (1983). Jerry Reiss is listed in Best Experts in America in Family Law and Employment Law. His principal offices are located in Ft. Lauderdale and Orlando.
A. Matthew Miller practices trial and appellate law in the Hollywood office of Boies, Schiller & Flexner, L.L.P., and is certified in marital and family law by The Florida Bar. He is a fellow of the American and International Academies of Matrimonial Lawyers and former chair of the Family Law Section of The Florida Bar.
This column is submitted on behalf of the Family Law Section, Scott Rubin, chair, and Susan W. Savard and Laura Davis Smith, editors.