DEFINED CONTRIBUTION PLANS GAIN AND LOSS ANALYSIS – COVERTURE FRACTION
For Defined Contribution Plans, such at 401(k), Thrift, Savings, Section 457 Plans, Section 403(b) Plans (Tax Deferred Annuities) a calculation of the current worth of a pre-existing marital balance often proves a most arduous task.
For example:
Assume your matter involves a 401(k) Plan with a pre-marital balance as of December 31, 1991 in the amount of $215,000.00. The accrual of marital assets in this plan began on January 1, 1992 and continued up to December 31, 2010. This is Josephine Sperry’s Plan. Her husband was David Gilbert Sperry. Josephine’s attorney was reluctant to pay the fee for an expert to perform a gain/loss analysis for the nineteen years (76 quarters), so that the parties would be certain of the current worth of the pre-marital balance in this plan. Instead, she elected to use a Coverture Fraction to determine the current worth of the pre-marital account balance. The cost of this Coverture Fraction calculation was $75.00. David Gilbert Sperry’s attorney promptly accepted this methodology.
Issue: Did Josephine’s attorney err in agreeing to accept the Coverture Fraction method to determine the current worth of the pre-marital part of this plan?
Let us examine the impact of the use of a Coverture Fraction to compute the current worth of the pre-marital share of Josephine’s plan.
Data, Josephine Sperry.
Date of hire: January 1, 1980
Date of Marriage: January 1, 1992
End of Marital Accruals: December 31, 2010
Based on the above the Coverture Fraction is: 61.29%
(19 ÷ 31).
The undisputed worth of Plan on 12/31/10: $696,442.26
If the Coverture Fraction is used the marital
Part of this Plan is: $426,851.71
($696,442.26 multiplied by 61.29%)
David’s Share (half of marital): $213,425.85
Josephine initially questioned her attorney regarding the merits of a Coverture Fraction to compute the pre-marital component of this Plan. Her attorney assured her that the Coverture Fraction is the most widely used method to compute the marital share of a pension benefit. Had Josephine’s attorney been more accurate she would have stated that the Coverture Fraction is the most widely used method to compute the marital share of a Defined Benefit pension benefit, however for a Defined Contribution Plan such as Josephine’s 401(k), the Coverture Fraction is not likely to produce a mathematically accurate result.
Relying on the advice of counsel Josephine accepted the Coverture Fraction calculation and David was assigned pursuant to a Qualified Domestic Relations Order, the sum of: $213,425.85.
Shortly after the divorce and QDRO transfer to David of $213,425.85, Josephine meets Rodger K. Hackenshmitt a nationally renowned Pension Evaluator. Roger indicates that Josephine’s election to use the Coverture Fraction may not have been in her best interest. To make the required 76 gain/loss calculations and prepare a gain/loss evaluation Rodger’s fee was $1,900.00. Rodger then presented Josephine with his findings.
Total worth of Plan on December 31, 2010: $696,442.26
Pre-Marital Account Balance: $215,000.00
Worth of gain on the pre-marital balance: $238,546.68
Total worth of pre-marital part on December 31, 2010: $453,546.68
($215,000.00 + $238,546.68).
Marital Part of Benefit: $242,895.58
($696,442.26 - $453,546.68)
Half of Marital to David: $121,447.79
Based on this mathematically accurate analysis
Josephine’s overpayment to David: $91,978.06
As a result of Josephine’s receipt of Rodger K. Hackenshmitt’s gain loss analysis it is likely that Josephine’s attorney will have a bad experience.
In making the above gain/loss analysis for this Practice Aid, Troyan, Inc. relied on the “S&P 500 Index” for the years 1992-2010. Its investment history is not untypical of the period. The results were:
| Year |
G/L% |
Year |
G/L% |
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001 |
7.62%
13.56%
-2.43%
25.75%
19.20%
20.28%
8.69%
7.35%
-14.17%
-11.89% |
2002
2003
2004
2005
2006
2007
2008
2009
2010 |
-22.10%
30.03%
10.88%
4.71%
0.10%
5.49%
-38.44%
26.46%
15.51% |
The average rate of return based on the above chart was: 5.61%
CAUTION:
It is Troyan’s view that use of a fixed rate of return based on an “artificial” average distorts reality since it eliminates the impact of years of loss from the calculation. For example if instead of doing the actual 76 quarters of gain/loss an evaluator simply used the average rate of return for the period of 5.61% the result would be:
THIS IS NOT A RECOMMENDED CALCULATION.
Starting Pre-marital Balance: $215,000.00
Assumed Rate of Annual Gain: 5.61%
Pre-marital Worth on December 31, 2010: $606,504.84
Marital Part: $89,937.42
Half of Marital Part to David: $44,968.71
The intent of Troyan’s illustration (immediately above) is to make clear that use of an “average rate of return”, enables a pension evaluator to abuse historical interest rates to distort a gain/loss. There are many other options available to attorney’s reluctant to pay a pension evaluator to perform the quarter by quarter gain loss analysis (if a plan is able to provide annual statements, the time and cost of this task is greatly reduced), however, each is likely to have a significant flaw. In preparing this Practice Aid, I built several spreadsheets that used alternate methods that generated results I deemed distorted.
I recognize that obtaining the data to perform the type of calculations presented above can be a challenge. When this circumstance arises, I think it prudent for attorneys to make clear to their clients the options available and the limitations of each alternative. Retain in your files a signed writing establishing that your client understood, that absent the necessary data, all that can be presented is an estimate that can vary significantly from a mathematically valid Gain/Loss analysis.
TROYAN INC. CONDUCTS SEMINARS ON ERISA, FEDERAL, MILITARY AND STATE RETIREMENT BENEFITS, NEGOTIATING STRATEGIES AND LANGUAGE FOR THE PROPERTY SETTLEMENT AGREEMENT. WE OFFER THIS TO COUNTY BAR ASSOCIATIONS OR FOR MEETINGS OF TWENTY OR MORE FAMILY LAW ATTORNEYS.