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QDRO Briefs Newsletter No. 8

Characterization of Defined Contribution Plans In Texas.

(December 1, 1999)

 

As we near the dawn of a new millennium*, there appears to be a lingering question of how to determine the character of a defined contribution plan. It is still a mystery. However, there is no great mystery in determining the value of a defined contribution plan. Since defined contribution plans are characterized by individual account balances, i.e, what you see, is generally what you get. This is not true in every defined contribution plan, however, the exceptions are rare. However, determining the marital, or community portion of that balance, is somewhat more difficult, thanks in part to a lack of understanding of these plans and the inconsistency in decisions by the trial and appellate courts.

 

Defined contribution plans can be described as pension plans in which both the participant’s and the sponsor’s contributions to the plan trust are defined at the time the contributions are made. The contributions are then invested in a variety of investment alternatives offered by the plan trustee. Examples of defined contribution plans or similar type of accounts are 401(k) plans, profit-sharing plans, savings and investment plans, Keogh plans (HR-10 plans), money purchase pension plans, thrift plans, Simplified Employee Pensions (SEPs) and Individual Retirement Accounts (IRAs) and the federal government’s Thrift Savings Plan. Defined contribution plans can be either qualified or non-qualified plans.

 

When a participant in a defined contribution plan or the owner of an IRA is married and, prior to the date of marriage, has a balance in the plan or account, determining the pre-marital or separate and post-marital or community portions becomes a little complex. Lack of clear guidance from the case law is but one factor. Accounting methodologies and accurate records are among others.

 

The issue of separate vs. community property has come before several Texas apellate courts. In Iglinsky, Pelzig, and Hatteberg, the appellants complained that the trial courts erred in dividing the defined contribution plans by use of the Berry formula. The Berry formula provides that the proper date for valuing benefits under a defined benefit plan is the date of divorce, not the date of retirement and included a formula which apportioned the benefits based on the term of the marriage and time of employment. Prior to the Berry case, the Taggart case had established an apportionment formula to determine the marital and non-marital portions of a defined benefit plan. That formula utilized the value of a plan’s accrued benefits at the time of retirement. Both the Berry and Taggart cases related to defined benefits plans. Each of the appellate courts in these cases agreed that the formula utilized in the Berry case was not appropriate to apportion the marital and non-marital portions of the plans in question.

 

In a footnote to the Iglinsky case the court stated,

 

"We do not disapprove of the trial court’s division of the accumulated funds into separate accounts. On the contrary, where an adequate accounting of contributions is available, this method of division appears to effect an accurate apportionment of benefits. Thus, if the court had determined the community interest in the funds on the basis of contributions of earnings during marriage and then proceeded to divide each fund into two accounts, each party would have received a proper share and would have equally borne the risk of non-maturity.

This comment appears to stand for the proposition that had the trial court based the apportionment on relative contributions, before and subsequent to the date of marriage, it may have upheld that type of decision. The appellate court in Iglinsky remanded the case back to the trial court for a new trial.

 

In Hatteberg, the appellant argued "that under Iglinsky, the proper calculation should be to subtract the value of the plan before marriage from the value of the plan upon divorce to find the community interest." Interesting enough, Iglinsky did not support that argument. Once again, the appellate court remanded the case back to the trial court.

 

In the Baw case, the appellant argued that the trial court erred by not applying the Berry formula. The trial court had characterized the community interest in the Husband’s profit-sharing-retirement-trust plan (a defined contribution plan) by subtracting the plan’s value at the date of marriage from its value at the date of divorce. The court overruled Husband’s point of error and concluded that the trial court had not abused its discretion in characterizing the community interest. The appellate court did not address whether or not the method utilized by the trial court was the only method appropriate, just that it did not abuse its discretion.

 

In Pelzig the appellate court took the position that the community interest was equal to the increase in the plan account balance between the date of marriage and the date of divorce and that result could be calculated simply by subtracting the balance of the account (in dollars) at the time of divorce from the balance of the account (in dollars) at the date of the marriage, the difference being community property. This decision flies in the face of all of the case law in Texas preceding it. This case stands for the proposition that "value" is the equivalent of property. Although not stating it, this case seems to create a new class of property, that is neither personal property or real property, called value, which could be "acquired" during a marriage.

 

In the Pelzig opinion the court stated (referring to Hatteberg and Iglinsky) "In both of those cases, the appellate courts simply subtracted the pre-marriage sum from the sum at divorce to determine the portion that was added during marriage and therefore is community property." In fact, that was not the case. The issue of how to value of the extent of community property was remanded in both of those cases. The decision in Pelzig may have been based on a faulty analysis of Hatteberg and Iglinsky by the appellate court. At the least enough doubt is raised to give pause to the "principals" of Pelzig.

 

It is interesting to note that in each of the cases cited above, the appellate courts did not try to distinguish between trusteed accounts (IRAs, SEPs, and defined contribution plans, etc.) and non-trusteed accounts (bank accounts and brokerage accounts). In each of these cases, the courts had ample opportunity to do so. Apparently, the courts have taken the position that there is no difference. Why then were these cases not decided in a manner consistent with the Texas Constitution, the Texas Family Code and other case law? If a trusteed account is no different than any other account, why were the accepted standards of tracing ignored? It could be that the record in each case did not include sufficient data to allow the appellate court to render decisions. It is odd, however, that the principals of tracing one’s separated property were not raised by the appellate courts in the opinions in these cases.

 

Assuming that there are no differences between trusteed and non-trusteed accounts, one can develop the argument that the principals of tracing apply, if sufficient data is available, as follows:

 

  1. The Texas Constitution defines separate property as "all property, both real and personal, of a spouse owned or claimed before marriage, and that acquired afterward by gift, devise or descent, shall be the separate property of that spouse."
  2. The Texas Family Code states "a spouse’s separate property consists of: (1) the property owned or claimed by the spouse before marriage."

 

It is generally accepted that one’s interest in a defined contribution plan on the date of marriage is separate property. It is also generally accepted that the inception of title rules do not apply to retirement plans. It therefore follows that benefits earned or acquired subsequent to the date of marriage are marital property.

 

Defined contribution plans increase in value in three (4) ways: additional contributions, ordinary earnings (dividends and interest income), capital gains and forfeitures. It is clear that the additional contributions made after the date of marriage are marital property. Retirement and pension plans are regarded as a mode of employee compensation earned during a given period of employment. If the employment takes place during the marriage, then contributions related to that employment are correspondingly marital property.

 

Absent any differences between a trusteed and non-trusteed account, it would appear that the rules of tracing apply to trusteed accounts equally as they would to non-trusteed accounts.

 

The general rules of tracing include the community property presumption that all property owned by the parties on the date of divorce is community property. In order to overcome the community property presumption, the party asserting the separate property ownership must clearly trace the original separate property into the particular assets on hand during the marriage. The degree of proof necessary to establish that property is separate property in order to rebut the community property presumption is clear and convincing evidence. Clear and convincing evidence is defined as that measure or degree of proof that will produce in the mind of the trier of fact a firm belief or conviction as to the truth of the allegations sought to be established. Property acquired in exchange for separate property becomes the separate property of the spouse who exchanged the property. As long as separate property can be definitely traced and identified, it remains separate property regardless of the fact that it may undergo mutations and changes.

 

A small number of courts, such as the Pelzig court, have taken the extreme position that the entire increase in the value of a defined contribution plan subsequent to the date of marriage is marital property. These courts have equated the difference between the balance (stated in dollars) on the date of divorce from the balance (stated in dollars) on the date of divorce as having been "earned" during the marriage. It is generally accepted that passive gains (capital gains) are not included in the category of "earnings". However, for some reason, unknown to the general public, these courts included passive gains as earnings without any explanation as to why.

 

In Welder the same appellate court that ruled in Pelzig stated "One dollar has the same value as another and under the law there can be commingling by the mixing of dollars when the number owned by each claimant is known" and "as long as separate property can be definitely traced and identified, it remains separate property regardless of the fact that it may undergo mutations." It is not an unrealistic leap to apply the same finding to a trusteed investment account stated in shares and / or units, nor does any case law prohibit such a finding.

 

Similarly, the 1998 Texas Pattern Jury Charges – Family, PJC 202.4 states "The character of separate property is not changed by the sale, exchange, or change in form of the separate property. If the separate property can be definitely traced and identified, it remains separate property regardless of the fact that the separate property may undergo mutations or changes in form."

 

The principals of tracing originated with the Sibley case. Since dollars are a fungible commodity, one dollar looks just like another, it was easy to establish a clear rule for following assets through a bank account. So too can securities be fungible, one share of common stock in ABC Company looks just like another share, and easy to trace through a securities account, trusteed or non-trusteed.

 

The State of Florida has faced this issue in two cases and found that distributions to non-participant spouses were not to include any part of the enhancement in value during the marriage which was due to passive accumulations on the husband’s non-marital portion of defined contribution plan.

 

The following is a simple example of the effect of (i) applying the Pelzig case versus (ii) applying traditional tracing methods:

 

H is a participant in the ABC Corp. 401(k) Plan, a qualified defined contribution plan. On H’s date of marriage the balance of his plan interest consisted of 100 shares of ABC Corp. with a market value of $30.00 per share. During the marriage the plan assets increased 500 shares of ABC Corp. with a market value of $70.00 per share.


Using the Pelzig analysis H’s separate property interest on the date of divorce would be $3,000 (100 shares X $30). Using traditional tracing analysis, H’s separate property would be equal to $7,000 (100 shares X $70).

How does one go about presenting the case that traditional tracing techniques are applicable to a defined contribution plan? The first and most obvious step is to get the attention of the trial court that you are going to present this type of analysis. Your opposition in this type of case will likely make the court aware of the Pelzig and Baw cases and will likely try and prevent any evidence to the contrary from being admitted. Make the court aware that there is no case law that distinguishes between trusteed and non-trusteed accounts, notwithstanding the decision in the Pelzig case. Make the court aware that the Pelzig court may have relied on a faulty analysis of the preceding cases. Put the case on in a Bill of Exceptions if necessary.

 

The responsibility for proving the non-marital portion of a defined contribution plan rests solely with the participant spouse. There is a presumption that the entire balance as of the date of divorce is marital property. However, the introduction of contrary evidence ends the presumption of community.

 

In order to trace the passive growth on the non-marital portion, it is first necessary to (i) determine the opening balance in units and value (ii) and produce all of the underlying data necessary to complete the tracing. This will normally require obtaining all, meaning every one, of the statements of the plan from the date of marriage to the date of divorce. The statements should include a history of all contributions, earnings, forfeitures, purchases, sales and transfers. Some plans maintain this data in a form that can be easily retrieved and some do not. In some cases it will not be possible to do a tracing which is clear and convincing and you may want to then rely of the Pelzig analysis. Lack of plan statements stand out as the major hurdle faced by a participant who attempts to trace the passive growth in a defined contribution plan.

 

Additionally, if the participant cannot prove the account balance at the date of marriage, the entire balance will likely be considered marital property.