Gallagher Actuarial Services

Frequently Asked Questions

(Pensions, Valuations, Marital Property, QDRO's)

or:
Questions That Should be Asked Frequently


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1. Are there different ways to account for a pension asset?

The major alternatives are to substitute another asset of equivalent value for the pension or to issue a domestic relations order against the plan to allocate to an alternate payee the benefits which are normally due the participant.

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2. How is the value of the pension determined?

If benefits are accumulating under a defined contribution plan (one that reports an individual account for the benefit of the participant, variously referred to as a 401(k), profit sharing, money purchase, target benefit, savings plan, etc.), the account balance is generally considered to be the value of the participant's interest in the plan. If the plan is a defined benefit plan (one that uses a formula to determine a periodic payment due upon the completion of certain criteria, including the "hybrid" and "cash balance" plans that appear to be defined contribution plans but are actually defined benefit plans), then an independent valuation must be obtained. Although various parties purport to provide this service, only an experienced pension actuary has the education and experience to fully analyze the sometimes very complicated benefit structures and apply the proper valuation procedures. (Actuaries are the professionals that Congress recognized as responsible for ensuring that employers properly funded the plans they sponsored.) Employers, and the consulting actuaries they have engaged to look after their plans, should not, because of their vested interests, provide the valuation.

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3. Are there any drawbacks to using the pension valuation?

If only the value of the participant's retirement benefit is used as an offset to other assets, the value of any survivor benefits that might have been payable to the former spouse if the marriage had continued are either lost or might become payable to a subsequent spouse. Only a domestic relations order can preserve this survivor coverage.

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4. Is "the marital portion of the pension shall be allocated 50% to the Participant and 50% to the Alternate Payee" sufficient for a settlement agreement or divorce judgment?

No, it does not sufficiently define all of the terms necessary for the process of translating it into official language for the Plan Administrator to implement.

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5. What terms are not defined?

"Marital portion" and "pension"; and there is no mention of ancillary benefits (survivorship rights, early retirement subsidies, cost of living adjustments, etc.).

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6. Are there different ways of determining a "marital portion"?

There are three generally recognized major methods of determining the marital portion of a pension benefit. Although they are referred to by a variety of names, and have many different methods of application, one shorthand nomenclature is: "coverture on divorce", "coverture on ultimate", and "direct difference". If the method of determining a marital portion is not defined, the Plan Administrator cannot determine what the awarded benefit is and must reject the proposed qualified domestic relations order ("QDRO").

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7. How does "coverture on divorce" determine the marital portion of a retirement benefit?

The term "coverture on divorce" refers to the award determined by multiplying the benefit determined using the plan benefit structure, in combination with service, salary, and/or benefit rates, as of the date of divorce (or separation or other "equitable" division date) by the ratio of marital service (or credits) as of that date to the total service (or credits) as of that date (coverture fraction at the time of divorce). This is akin to answering the question, "What is the pro-rata marital portion of the benefit payable assuming termination of coverage at the date of divorce?"

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8. How does "coverture on ultimate" determine the marital portion of a retirement benefit?

The term "coverture on ultimate" refers to the award determined by multiplying the benefit determined using the plan benefit structure, in combination with service, salary, and/or benefit rates, as of the ultimate date of termination or retirement by the ratio of marital service (or credits) to the total service (or credits) as of that ultimate date (ultimate coverture fraction). This is akin to answering the question, "What is the pro-rata marital portion of the benefit payable upon ultimate termination of coverage?"

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9. How does "direct difference" determine the marital portion of a retirement benefit?

The term "direct difference" refers to the award determined by subtracting the benefit determined using the plan benefit structure, in combination with service (or credits), salary, and/or benefit rates, at the time of the marriage, from the benefit determined using the plan benefit structure, in combination with service (or credits), salary, and/or benefit rates, at the time of divorce (or separation or other "equitable" division date). This is akin to answering the question, "What is the difference between the benefit that would have been payable assuming termination of coverage at the date of marriage and the benefit that would have been payable assuming termination of coverage at the date of divorce?"

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10. Are there different methods for calculating a "coverture fraction"?

Typically, this term refers to the ratio of marital service to total service used in the allocation. It is important to maintain some consistency in the numbers that are in the numerator (top number) and denominator (bottom number) of the fraction. A simple calculation of the elapsed time from first employment to the relevant determination date may not be appropriate. That is, some plans use periods of service or employment in determining a benefit, others use periods of participation, or grant special credits for other periods of time (medical leave, approved leave of absence, unused sick or vacation time, etc.), or even grant extra credits to encourage retirement (e.g., early retirement incentive programs). Special consideration may have to be given to periods of part-time employment, leaves of absence, or breaks in service. The inclusion or exclusion of these credits in either part of the fraction should be knowingly made. (And be sure to consistently account for, or apply, fractional credits too!)

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11. Which marital allocation method is "best"?

The three methods have advantages and disadvantages that should be carefully considered in the deliberations. "Best" is too subjective a term for this forum, and depends heavily on the needs in each individual circumstance, and the orientation of the questioner. And there can certainly be as many variations on the themes as there are different benefit structures in the myriad pension plans in existence.

In pension terms, the coverture on divorce method effectively assigns a pro-rata portion of the effect of salary at divorce to each prior period of service, including the premarital period.

The direct difference method reserves the effect of all marital salary to the marital benefit. If the plan benefit structure has changed, it also assigns the effect of any change wholly to the marriage. (Note: if there is no non-marital period of service, coverture on divorce and direct difference result in exactly the same marital assignment.)

The coverture on ultimate method assigns a portion of the effect of post-divorce salary and service to the marital allocation.

The choice of method depends on the objectives in each particular case. Keep in mind that some plans, or jurisdictions, may specifically define one choice that will be used if the agreement is ambiguous. For example, the procedures for the Civil Service Retirement System ("CSRS") specify that, absent clear statements to the contrary, the coverture on ultimate method will be used. This is also the basis for New Hampshire allocations based on the so-called Hodgins decision (even though a precise reading of the original decision shows that inconsistent terms in the numerator and denominator definitions were used: service vs. participation).

This is where the needs of the parties must be considered, and the judgment of the advocates employed. The expert needs to explain all of the options and how they affect the allocation, but should refrain from interjecting a personal interpretation of "fair" or "best".

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12. What is the benefit that is being divided?

The term "pension" is generally understood to mean the amount of the monthly benefit payable to the plan participant upon his (or her) eventual satisfaction of the payment commencement criteria, but it really encompasses much more. All pension plans define the retirement benefit in terms of three items: the amount of the periodic payment, when payments commence, and the contingencies for continued payment. But, in addition to the normal retirement benefit, many pension plans include various ancillary benefits such as survivor benefits, early or disability retirement benefit options, and termination benefits. If the effect of each of these options is not included in the deliberations, there may be an unintended consequence when payments come due.

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13. What are some of the issues that need to be addressed in determining the allocation of a pension asset?

A particularly effective way to visualize the situation is to divide a sheet of paper into four quarters by a line down the middle and another line across the center. Label the left and right sections something like "participant alive" and "participant dead"; and the top and bottom sections "alternate payee alive" and "alternate payee dead". Now fill in the box with the answers to the questions, "What gets paid to whom when...?" (For an example of this box, click here.)

When both of them are alive, do they share each payment that is made to the participant "if, as, and when" it is due? Does the awarded benefit get completely separated so that the death or survival of one does not affect payments to the other? Can the alternate payee start to receive payments prior to the retirement of the participant? Once the participant does retire, is the election of a particular optional form of distribution required?

If the alternate payee dies first, does the award revert to the benefit of the participant? if not, to whom (or to what) is it paid? (If the award was implemented as a "separate interest", it may simply end and the plan has what is called an actuarial gain.)

If the participant dies first, do payments to the alternate payee also stop? (They will if the award was implemented as a "shared interest".) Is the alternate payee to be treated (or continue to be treated) as a surviving spouse? If so, for how much of the survivor benefit? (Can a subsequent spouse receive any survivor benefits?) If the alternate payee is eligible for survivor benefits, should the value of such survivor benefits affect the allocation of the payments made while both are alive? (If the joint payments are split 50/50, then the additional award of survivor benefits may skew the overall value of the award significantly in favor of the alternate payee.)

After both of them die, who (or what) receives any remaining survivor benefits?

As if all of this wasn't confusing enough, you might have to perform this "box" exercise more than once to cover payments that can be made as a result of pre-retirement benefits under the terms of the plan: is the alternate payee to be treated as the surviving spouse for purposes of the pre-retirement survivor benefits if the participant dies prior to the commencement of any retirement payments?

And don't forget to include whether the alternate payee is eligible to share in the effect of any early retirement subsidy, or post-retirement cost of living adjustments. Of course, the administrative procedures of the plan may dictate some of the answers, or restrict some of the options too. You may need to carefully review the plan document (or at least the Summary Plan Description ("SPD")). It might also be beneficial to obtain a copy of the plan's QDRO procedures and any model documents that would simplify the process.

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14. What is a "shared interest" allocation?

A "shared interest" is when each party receives a share of each payment from the plan "if, as, and when" it is made. Some plans allow only this type of allocation since the basic design of a pension plan is to provide income to the participant upon his/her retirement. That is, the "retirement" benefit is just that, a periodic payment made to the participant upon his termination of employment and retirement. If the participant does not survive to receive the scheduled payment, it will not be paid. In this case, if the alternate payee does not retain any rights to survivor benefits, her/his "share" of the retirement benefit ceases upon the death of the participant. Upon the death of the alternate payee, her/his allocated share can revert to the benefit of the participant (although some awards require the continuation of payments to the alternate payee's estate or other named contingent alternate payee(s) (the children?)).

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15. What is a "separate interest" allocation?

A "separate interest" is when the portion of benefits allocated to the alternate payee is completely separated from the effect of the survival of the participant. Many plans allow, and some require, this type of allocation because it can simplify administration: the death, or survival, of one party does not influence payments to the other. In this case, there may be no need for the continued treatment of the alternate payee as a "surviving spouse" of the participant, but it also prevents (usually) the reversion of the allocation to the participant upon the premature death of the alternate payee. It is important to understand whether this "separation" occurs at the time of the plan's acceptance of the allocation or upon the eventual commencement of payments. The delay of "separation" might indicate the need for a continuation of pre-retirement survivorship coverage.

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16. Is there a simple settlement agreement format that might better address the issues?

A better suggestion for the format of the settlement agreement might be something like: "The marital portion of retirement benefits payable from (plan) shall be divided (50/50). The marital portion of the retirement benefits shall be determined by multiplying the [(benefit determined using salary and service as of (the date of divorce)) or (actual retirement benefit)] by the ratio of marital service to total service (as of (the date of divorce)). (Length of service shall be calculated to the nearest month.) (Alternate payee) (shall/shall not) continue to be treated as the spouse for the purposes of any pre-retirement surviving spouse benefits (derived from the above marital portion). (Alternate payee) (shall/shall not) share in any proportional early retirement incentives or post retirement benefit adjustments." (This still isn't an exhaustive statement, but it might clarify several issues when the time does arrive for the QDRO draft.)

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17. Is there any case law which addresses this situation?

Certainly, there is case law in many jurisdictions on many topics and it would be a full time job to review them all. One local decision, however, might be interesting reading: In the Maine Supreme Court, Greenwood v. Greenwod, Decision: 2000 ME 37, there were really two issues: 1: the original court order tried to have the plan pay a benefit which it could not pay (a lump sum); and 2: the settlement agreement, by explicitly including a statement about the value of the marital benefit, effectively defined the exclusion of any early retirement subsidy from the award. (The issue was raised by the attempted inclusion of the subsidy in a domestic relations order that had been revised to correct the unavailable form of distribution.)

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18. What are the general requirements for a domestic relations order against the plan?

ERISA (the 1974 pension legislation, and it's 1982 amendment) governs the requirements for plans which have tax qualified trusts. Although this legislation coined the acronym QDRO (for qualified domestic relations order), and many other pension programs specifically announce that they are (rightfully so) not subject to ERISA (notably government plans) and that the QDRO provisions and rules do not apply to them, most of these other plans have instituted similar rules. In general, all plans need the same things in the order, no matter whether they call it a QDRO or a qualifying court order or something else:

It may also be a good idea to include identification of legal counsel for both parties so that communications are routed to all interested parties.

If possible, obtain a copy of the court order procedures of the plan and any model orders that they may have prepared to ease their administrative burden: if it is possible, following the format they are familiar with makes their review more efficient and provides information about any special restrictions or options that might influence the course of settlement negotiations.

You might find this checklist useful!

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19. What can a domestic relations order not do?

A domestic relations order allocating a portion of a participant's benefits to an alternate payee cannot order the plan to pay benefits that it normally would not pay.

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20. Is the valuation date important?

When a settlement includes reference to a specific value, especially of an account balance, it may be important to keep that date as part of any official reference to that asset. That is, a settlement agreement that simply states that "50% of the account balance is awarded" may cause an unanticipated problem: are deposits to the account that are made after the valuation date to be included in any distribution to the alternate payee?

If the settlement agreement doesn't specify that the award is defined by reference to a specific date, the drafter of the QDRO has no way of knowing whether later deposits are included or excluded.

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21. Should investment income, gains, and/or losses be referenced?

The agreement should also specify whether any distribution to an alternate payee should include or exclude any investment changes in the account after the valuation date. A statement like "$52,875 is awarded" could be taken to mean that the big investment gains or losses made after the valuation date are to be retained entirely by the participant. This windfall, or penalty, may not be the intended consequence of an otherwise well crafted equitable settlement.

Without a clear settlement agreement statement, the QDRO drafter could inadvertantly (or intentionally) benefit one party over the other.

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Michael E. Gallagher
Gallagher Actuarial Services
P.O. Box 297
Sebago, ME 04029-0297
(207) 650-6405
email: actuary "at" galactser.com

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