Lexington Pension Consultants, Inc.

Overview of Valuation Methods & Analysis and Qualified Domestic Relations Orders (QDRO) for Equitable Distribution Purposes

Replacing Lost Benefits
Defined Benefit Plans - Determining Present Value
Disability Benefits
Defined Contribution Plans
Benefit Offset Calculation
Tracing/Segregation Method
QDRO Preparation Services
Settlement Agreement Consultation
Report/QDRO Review and Critique

Replacing Lost Benefits
In matrimonial actions, the basic logic behind the need for determining the present value of an individual’s accrued pension benefit is to determine the replacement cost of that benefit. While the parties were married, there was an expectation that they would share in this benefit at retirement. Now, upon divorce, since marital assets must be distributed equitably between the parties, there is a need to determine the value of each of these assets, including the replacement cost of the pension benefit. Once the values of all assets are determined, the parties can offset the values of these assets so that they are distributed equitably.

Defined Benefits Plans - Determining Present Value
A Defined Benefit plan is a traditional pension plan in which there will be a monthly amount payable at retirement based upon a formula as described in the plan’s Summary Plan Description. An example of a typical defined benefit plan formula is as follows: a percentage (1.5%) multiplied by the years of credited service (25), multiplied by the final average salary ($65,000). Under this example, the annual accrued benefit would be $24,375.00 (1.5% * 25 * $65,000 = $24,375). When calculating the present value of pension benefits, many factors affect the ultimate determination of this value. In general, if a person is young, has many years of deferral until the commencement of pension benefits and the payments begin at a later age, such as age 65, these factors will result in a lower present value. Conversely, if the person is close to retirement age and can begin collection of benefits at a relatively young age (such as a 40 year old police officer with 18 years of service and a 20 year retirement), the value would tend to be higher because the payments commence earlier and continue for many more years. The other major factor in determining the value is the choice of an interest rate assumption. Our firm currently uses the immediate and deferred interest rates as published by the Pension Benefit Guaranty Corporation ((PBGC). The PBGC is a quasi-governmental organization which underwrites all private pension plans throughout the country and provides a fair and impartial source of interest rates. You may view samples of our typical ERISA Pension Valuation Report or Government Pension Valuation Report by clicking these links.

Disability Benefits
The valuation of disability pensions is also a source of concern for matrimonial attorneys. Most jurisdictions hold that only that portion of the disability pension which was accrued due to service is subject to equitable distribution. Therefore, it is imperative to obtain all the necessary salary and credited service information from the Plan in order to calculate the non-disability portion of the pension benefit..

Defined Contribution Plans
Defined Contribution Plans consist of any type of tax deferred plan which has individual accounts for participants. Contributions into the account may come from the employer and/or employee. Investment risk is borne by the employee. The common types of defined contribution plans are profit-sharing, 401(k), thrift/savings, Keogh and Target plans. The value of these plans is based upon the current value of invested assets at any given point in time. When examining these plans for equitable distribution purposes, the value is relatively easy to determine when all of the value has been earned during the marriage. If a portion of the account was in existence prior to the marriage, the pre-marital portion has to be established. There are several methods used to determine the marital and non-marital portions of an account. The Tracing/Segregation Method is the most accurate and preferred method used to determine the marital and non-marital portions. (See a further explanation and example of this method below). Unfortunately, the Tracing Method requires an analysis of all account statements from the date of marriage to the date of the action for divorce. Often these records are not available. Alternative methods of determining the marital portion of a defined contribution plan account are the Subtraction Method and the Coverture Method. The Subtraction Method is calculated by determining the account balance as of the Marital Asset Cutoff Date and subtracting from it, the account balance as of the Date of Marriage. The difference in the balances is the portion of the account that accumulated during the marriage. The Coverture Method is calculated by dividing the number of years married while participating in the plan by the total years in the plan. This calculates a Coverture Fraction, which is then multiplied by the account balance on the valuation date.

Benefit Offset Calculation
When determining the division of assets, the value of all assets must be determined, then these assets must be divided or offset against one another. In many cases, both husband and wife are entitled to retirement benefits, have a mutual interest in the marital residence, or other assets which may be held as individuals. Dividing these assets for equitable distribution purposes does not always result in an even distribution of assets. Often, when dividing a defined benefit plan, the spouse may be entitled to a reduced portion of the benefit after the offset. The purpose of this calculation is to determine the reduced percentage of the marital portion of the defined benefit pension. Click here for examples of offset calculations.

Tracing/Segregation Method
Establishing the value of a defined contribution plan is easy. Just read the statement. If the account balance has been accumulated entirely during the marriage, the parties may use the balance for the appropriate date and decide how it is to be divided. A problem arises when there was a balance in the account prior to the marriage. A typical scenario illustrating the problem goes like this: The parties were married on December 31, 1994, and at the time of the marriage, the husband was a member of his company’s savings plan since December 31, 1989, with a balance of $32,332. During the marriage, he continued to contribute marital money into the plan. On the date the action for divorce was commenced, the balance of the account was $142,449.

Using the Subtraction Method yields a marital accumulation of $110,117. Using the Coverture Method yields a marital fraction of 66.3% (9.84 years married while employed, divided by 14.54 years employed, equals 66.3%). 66.3% of $142,449 is $94,450. Both of these methods are inaccurate when being used for equitable distribution purposes. The Subtraction Method is inaccurate because it fails to attribute the earnings on the pre-marital balance to the pre-marital portion. The Coverture Method is inaccurate because the coverture fraction is determined by years of marriage and service, not the rate of contribution or earnings. If the participant had been employed for a longer or shorter period of time, it would have affected the coverture fraction, having no direct relationship to the actual amounts accumulated during the marriage. Unfortunately, if the records are not available, either of these two methods may be the only viable alternative.

Utilizing the Tracing Method is without a doubt, the most accurate method to determine the marital and non-marital portions of defined contribution plan accounts. This method examines the actual investment experience of the account during the whole marital period. Any earnings or losses are determined on a proportionate basis from quarter to quarter. Also, any loans or distributions which were made during the marital period can be properly accounted for. As shown in our example, the parties took a $30,000 loan in June of 2000. The actual marital portion of this account is $73,335, with the original pre-marital balance having grown to $69,087. Click here to view an example of the Tracing/Segregation Method.

QDRO Preparation Services
In 1974 Congress passed the Employees Retirement Income Security Act ((ERISA). This act defined, clarified, standardized and protected employees’ rights to pension benefits. It also stated that pension benefits were "non-assignable", thereby shielding these pension benefits from all creditors. Realizing that there was an inequity concerning the marital property rights of spouses and former spouses, in 1984 Congress passed the Retirement Equity Act (REA). This Act defined the rights of spouses, former spouses and dependents, and stated that pension benefits could be assigned pursuant to a "Qualified Domestic Relations Order" (QDRO). As defined under the REA, a "Qualified Domestic Relations Order" (QDRO) means a Domestic Relations Order (DRO) which "creates or recognizes the existence of an alternate payee's right to, or assigns to an alternate payee, the right to receive all or a portion of the benefits payable with respect to a participant under the plan."

We have been providing assistance in the preparation of QDROs since 1986. We have prepared over 15,000 Domestic Relations Orders for our clients. It is important to note that we are a full service firm. We prepare the DRO based upon the specifics of the agreement. Upon approval of the requesting attorney that the DRO accurately reflects the terms of the agreement, we then forward the draft to the appropriate pension/retirement plan to obtain pre-approval. This is a very time consuming but important step in the process. It has been our experience that if there is the slightest inconsistency in conforming to the plan’s rules, the plan will not pre-qualify the Order. We will not stop working for you until your DRO is pre-approved by the plan and ready for the Court’s certification. Many of our competitors will provide you with the DRO, but will not provide the extra service of having it pre-approved by the plan. If a Court certified Order is rejected by the plan, the whole process must be repeated.

Settlement Agreement Consultation
When attorneys negotiate the terms of a Settlement Agreement, one of the most complex aspects of the Agreement is the equitable distribution of retirement assets. Several steps are required:

Step one - the marital portion of each spouse’s retirement benefits must be determined. This often requires a present value analysis or Tracing Method calculation.

Step two – the benefits may need to be offset against one another or other assets, such as the marital residence. In many instances, one spouse may be entitled to a reduced portion of the other spouse’s retirement benefits, after the offset calculation is performed. This benefit may be payable in the future via a Qualified Domestic Relations Order (QDRO).

Step three – when benefits are to be divided via a QDRO, attorneys must be very specific in describing how these benefits are to be divided. Merely stating that the spouse is to receive an agreed upon percent of the marital portion of a retirement plan benefit or 401(k) type plan, is woefully inadequate. Several additional issues must be negotiated and included in the Agreement. Pre and post retirement death benefits, cost of living adjustments, adjustments for earnings or losses experienced by the account between the division date and the distribution date are just some of the issues to be addressed.

Step four – once the above issues are resolved, if a QDRO is necessary, the terms of the Agreement as it relates to the retirement benefits, must be acceptable and “Qualified” by the retirement plan. If the parties agreed to divide the marital portion without specifying the amount, the plan may be unwilling to perform that calculation. Some plans will not accept asset division dates that go back more than a year, some require a specific dollar amount rather than a percent or formula. Refusal by the plan to implement the terms of the Agreement may force the parties to renegotiate the settlement.

Lexington Pension Consultants, Inc. can help matrimonial practitioners avoid many of the pitfalls associated with distributing retirement assets. We have over 20 years of experience in assisting attorneys in negotiating settlements, calculating the marital value of benefits, offsetting assets and dealing with retirement plans. We have extensive knowledge of retirement plan rules and requirements.

Our Settlement Agreement Consultation service will assist attorneys throughout the whole process, that may include, but not be limited to, the determination of the value of the retirement assets, offsetting the assets if necessary, preparing the appropriate and complete language for the Agreement and preparing the appropriate QDRO(s) and obtaining pre-approval from the retirement plan(s). The fee for this service will depend upon the complexity of the case.

Report/QDRO Review and Critique
We will review an opposing expert’s report and provide either an oral or written report of our findings. We will provide an analysis and opinion of the methodology and conclusions of the opposing expert..

We will review an opposing attorney’s proposed Domestic Relations Order (DRO). A successful “Qualified” Domestic Relations Order (QDRO) must contain all of the aspects of the parties’ Agreement and must also be acceptable to the plan. If the terms of the Agreement and the DRO are not acceptable to the plan, the plan will not “Qualify” the DRO. An example of this would be if the parties agreed to provide a lump-sum payment to the spouse, but no lump-sum option is available under the plan’s rules.

Our review will include an analysis of how accurately the DRO reiterates the parties’ Agreement, and our opinion as to whether or not the terms of the DRO will be acceptable to the plan.