The Pension Cases: A Shift in Treatment of Retirement Benefits from Property to Income
Law regarding pensions and retirement benefits as a marital asset is barely ten years old. Whether inspired by the limitations of the Social Security system, or demanded by the first post-depression generation, funding of retirement plans has become an important compensation component. the high divorce rate made litigation over this issue inevitable.
The earliest cases held that rights in a pension plan or retirement benefit accrued during the marriage are part of the marital estate and subject to division by a trail court. Subsequent cases considered the asset "property" and focused on the "present value" of the benefits.
Developing case law, coupled with enabling federal legislation, recognizes that pension plans and retirement benefits are, for the most part, an anticipated future stream of income.
The alternative of dividing the income stream itself, as opposed to "setting off" the value with other property to the non-employee spouse, spreads the risk of its deferred method of payment and avoids valuation problems.
EARLY CASES DEFINE RETIREMENT BENEFITS AS AN ASSET
In Hutchins v Hutchins, it was held for the first time that accumulated salary deductions payable to the employee upon retirement are funds which would have been available during the marriage and therefore are includable in the total assets of the parties subject to division in a divorce proceeding.
The trial court excluded the retirement payments Mr. Hutchins was receiving from any consideration in the distribution of assets or in alimony. On remand, the Court of Appeals did not require an actual apportionment of the funds, but rather an examination of it as "one element" in determining the allocation of assets and alimony obligations.
Interestingly in retrospect, the court also reversed the alimony award in lieu of:
"whether the alimony should be eliminated if [the trial court] is of the opinion that the new division of the parties’ assets, which he is to make, renders it advisable."
Clearly, the Court of Appeals in the very first retirement case, was inferring that an apportionment of the retirement stream of income is acceptable.
In Miller v Miller, the Court of Appeals similarly held that an interest in a pension plan, funded entirely by employer contributions is distributable pursuant to a divorce. There, the benefits were vested but not scheduled for payment until retirement several years in the future.
Building on Hutchins, the court held:
"We believe the same result should obtain when the pension is funded directly by the employee . . . to the extent that the interest is marital property with a reasonably ascertainable present value."
By the end of the 70’s, it was clear that an interest in a pension plan was a marital asset subject to division upon a divorce. There remained unanswered questions: If this asset is treated as a stream of deferred income payments, how to order apportionment, or if property, how it is valued at the time of the divorce?
THE "FORMULA" CASES – TREATMENT AS PROPERTY REQUIRING SET OFF
Cases decided in the early and middle 1980’s dealt with how to value and distribute this new marital asset. Because there was no meaningful tool to insure payment of the deferred income stream, case law focused on present value plus immediate distribution by setting off its value with other property awarded the spouse.
In Boyd v Boyd, the most cited retirement case, the Court of Appeals considered retirement benefits as an asset to be valued at its present worth. The court established the following guidelines:(a) Determine from statutory mortality tables the likelihood of the party surviving to the date the pension benefits are available, often called mortality rate
(b) Determine the life expectancy of the party at the retirement age.
(c) Multiply the monthly benefits times the months of statutory actuarial life expectancy.
(d) Reduce this figure by the mortality rates that the person would die before the actuarial date.
(e) Reduce this figure to present value.
The problem, as the Boyd court noted, with the "set off" method was "under the holding of this opinion, some inequities would probably result."
For the intended result to happen, a number of assumptions required for the calculations all had to be correct: Survival of both parties, assumptions of future interest rates during times of inflation and deflation, the pension holding spouse not living significantly longer than the expected lifespan and obtain a disproportionately higher share of the martial estate, and sufficient assets in the estate to offset the award of this presently valued property to the non-pension holding spouse.
The Boyd court did briefly discuss other alternatives. It said:
"We have discussed the distribution of potential pension benefits as if they must be reduced to the present value and distribute immediately. In fact, this is only one possible means of distribution. In Chisnell v Chisnell (citations omitted), affirmed a distribution of pension benefits as they were received by the pension holding spouse . . . this method of distribution would eliminate the inequity of a pension holding employee ‘buying out’ his spouse’s pension interest and dying without ever receiving anything [or] eliminate the possibility of the pension holding employee’s interest in the pension being far more valuable than it would be expected based upon life expectancy so that the non-pension holding spouse would be shorter."
However, the court admitted no dependable tool existed. Deferred distribution was only available where the parties "are not extremely bitter and hostile so that the pension holding spouse could be counted on to provide his ex-partner with her share of the pension as ordered."
Perry v Perry cited Boyd with approval. By force of weight, case law established the reduction to present value/set off method as the preferred, if not exclusive method, and the distribution of deferred income method, no doubt partly because of perceived enforcement problems, moved to the background.
Zecchin v Zecchin involved a predictable battle of experts over the present value of a retirement plan. Interestingly, the trial court, and the Court of Appeals rejected the expert who testified in accordance with a Boyd v Boyd calculation. the husband’s expert advocated use of an "annuity method."As any insurance salesperson or estate planner will tell you, an annuity can be described as follows: How much money would I have to put in the bank today (assuming an interest rate) to produce the desired dollars per month at a time in the future?
As the experts testified, the enormous variety of speculative assumptions required in a "present value" calculation, i.e., interest rates, retirement dates, mortality assumptions, tax considerations and more, make the valuation of this asset overly complex given its relatively simple premise: At a certain age, upon retirement, a person is going to receive X dollars a month until he or she dies.
The inherent inequities of the present value/offset method spurred congress in 1984 to enact remedial legislation in the form of the Retirement Equity act ("REA").
The REA creates a procedure whereby a state court can enter an order providing for distribution of benefits as they become available to the retired employee.
The procedure is known as a "Qualified Domestic Relations Order." QDRO’s, as they are called, permit pension plan administrators to make deferred distributions of benefits to former spouses (renamed alternate payees) when, if, and as collected in whatever pro rata division the parties or the court decides. As has already been pointed out by the commentators, this method evenly distributes the risks, eliminates enforcement problems and results in fair and predictable tax consequences.
QDRO’s emanate from an entirely different philosophical underpinning than that previously employed in the case law: It treats the benefits for what they really are; a stream of benefits, typically in the form of monthly payments, paid at a future date. In other words, the benefit is treated as income which more reasonably relates to support than property.
Recent decisions, while not uniform, are trending toward treatment of retirement benefits as a future income stream capable of division and deferred distribution, rather than "property" requiring a present value and a set off against other property.
Beaty v Beaty is a good example. This case concerned both a Miller and a Hutchins situation: Vested rights in contributory and noncontributory pension plans. The husband was entitled at age 65 to $376 per month from one plan and $604 per month from the other. A long term marriage, the court divided the balance of marital property equally, while it awarded each a half interest in the contributory plan, it awarded the husband the entire noncontributory plan.
Both the trial court and the Court of Appeals were troubled by the lack of testimony as to "present value." The Court of Appeals found error in not making a finding of fact as to the present value of the contributory pension, in spite of the fact that each party was granted one-half interest in it and refused to reconsider the award of the noncontributory plan.
Assuming the trial court’s intent was to equally divide the pension plans as it did the balance of the property, a simpler result would be to order entry of a QDRO to provide at age 65, for each party to receive one-half of the benefit, or $490 a month.
Judge Shepard would have agreed. In his dissenting opinion, he would require:". . . the non-contributory pension plan held in abeyance until it became a liquid asset. I would . . . fashion a Hatcher-type remedy or any other appropriate remedy that would be equitable."
A QDRO would not only be the vehicle to divide this asset, but it would also have served the purpose of a pension plan for both parties: Retirement income.
Judge Shepard was also accurate in suggesting that this asset relates to family income, not property, and that the alimony award to the wife should be reconsidered in view of this treatment.
Kilbride v Kilbride offers additional guidelines, but its legacy may be that its complexity will motivate the bench and the bar to utilize the QDRO more extensively.
The key holding of the Kilbride decision is fundamentally sound:
"We direct that the method employed not be dependent on the amount of the future benefit actually paid to the employee’s spouse."
Unfortunately, the Kilbride holds that it is necessary to determine the "value" of the pension at the time of the divorce, and relegates the "other methods," described above, to a footnote.
Kilbride reiterates, like the earlier decisions, the problems associated with the present value offset method:
"A somewhat complex matter which lends itself to manipulation and exaggeration by the parties (a battle of the experts) to achieve a low or high figure as their respective interests may demand."
The opinion then offers "guidelines," actually a series of assumptions, requiring five pages of explanation.
In the 1989 decision Kurz v Kurz, the majority instructed the trial court to determine "present value" using the live annuity method employed in Zecchin or the life expectancy method employed in Boyd. The court chose "not to follow" Kilbride. It stated:
". . . the pension valuation method used in Kilbride, supra, as that case has been the object of criticism from certain family law experts."
In Judge Murphy’s dissent, the QDRO alternative is discussed in an opinion for the first time. Providing good guidance for the future, he states:
". . . reducing pension benefits to present value and requiring that a non-participant spouse receive ‘offsetting assets’ of comparable values is not always feasible. These concerns in part brought about the Qualified Domestic Relations Order (QDRO) . . . the QDRO is meant to provide a mechanism to accommodate deferred distribution of pension interest."
As is pointed out, present value of property is not always required. An example is the marital home that will be ordered sold and the proceeds distributed. Continuing, the dissent states:
"The trial court must be permitted to establish present value in cases where it is appropriate but must not be precluded from following a course of distribution that provides for benefits when, if and as the befits are paid."
Kurz v Kurz is also noteworthy because it was reviewed and considered on application for leave to the Supreme Court. The Court provides us with tacit, yet valuable guidance that supports our conclusion:
"In these circumstances, the provisions for alimony and property division should be considered together."
In other words, where a significant asset of the parties is a retirement plan, it is more appropriate, to say nothing of fairer, to treat it as a deferred stream of income, and from this aspect, consider the amount and length of alimony where it is otherwise a factor. With the advent of QDRO’s case law is clearly moving more and more toward the alternative treatment of retirement benefits that provide future income not as property, but as a component of income capable of deferred distribution.