CHARLA H. BRADSHAW KoonsFuller Family Law (Managing Shareholder) Denton, Southlake, Plano, Dallas and Houston 320 West Eagle Drive, Suite 200, Denton, TX 76201 Phone: 940.442.6677 Fax: 940.442.6671 charla@koonsfuller.com Charla has considerable expertise in providing family law services to a broad range of clients with concentration in the area of family law, and including employee benefits, executive compensation, and retirement. She frequently serves as attorney in diverse legal cases, and is an expert to other attorneys in the areas of employee benefits, executive compensation, and retirement. Charla graduated from SMU Law School in 1993 and graduated from Texas Woman's University Summa Cum Laude. Charla has been in: “Best Lawyers in America” since 2011; Best of Denton County 2016: Best Divorce Attorney; Texas Super Lawyers®, Texas Monthly Magazine, Texas Super Lawyer, 2003 ~ 2019; Texas Super Lawyers®, Texas Monthly Magazine, Top Fifty Female Attorneys in Texas, 2005, 2013, 2014, 2015 and 2019; Texas Super Lawyers®, Texas Monthly Magazine, Top 100 Super Lawyers® in Dallas/Fort Worth, 2005, 2014, 2016 and 2019; Texas Super Lawyers®, Texas Monthly Magazine, Top 100 Super Lawyers® in Texas, 2014 and 2019; D Magazine Best Women Lawyers (2010). She is Martindale Hubbell AV® Peer Review Rated and she won Best CLE Article of 2007, State Bar of Texas, Family Law Section, Charla is the Past President, and member of, the Texas Academy of Family Law Specialists. She has been the course director for Advanced Family Law, Marriage Dissolution, TAFLS Trial Institute, and New Frontiers. She has been a member of the State Bar of Texas Family Law Council Legislative Committee (2009 to present) and Publications Committee, and is Past Chair of Section 14, State Bar of Texas Grievance Committee and Panel Member (2008-2013). She is Committee Chair of the State Bar of Texas Family Law Section publication “Fast Guide to Family Law: Checklist for Everyday Practice”. Charla has written and presented in numerous family law CLE courses and fiduciary CLE courses, for the State Bar of Texas and other legal organizations.Division of Retirement and Division Orders Chapter 27 3. Hybrid Plans There are two hybrid plans that have the characteristics of both a defined contribution and defined benefit plan: money purchase pension plans and target benefit plans Ina money purchase pension plan, the employer's annual contribution to the plan is determined by a formula that is usually a percentage of the participant's, compensation. Because it is a defined contribution plan, the amount of the participant's benefit is not guaranteed, but rather the account balance at the time of retirement is the benefit payable to the participant. The difference between a defined contribution plan and a money purchase plan is that annual contributions are not atthe discretion of the employer: In a target benefit plan the contribution the employer makes to the plan is based on the amount needed to fund a benefit for the participant to pay a projected retirement benefit (the target benefit). In a target benefit plan, only the contribution is guaranteed, not the retirement benefit. The contribution formula in, «a target benefit plan is based on the promise to provide ‘certain fixed benefit at retirement. B. Distinguishing Between Defined Benefit and Defined Contribution Plans One of the most common mistakes is when the benefit is divided in a form not allowed by the plan There are distinctive differences between a defined benefit plan and a defined contribution plan. One should not letthe name of the plan mislead them, Often the plan will use the word “retirement” or “pension” in the name of a defined contribution plan, leading one to believe itis a defined benefit plan. It is imperative to know the type of plan being divided. This is also pertinent to tracing separate property as to whether the tracing rules for defined benefit plans apply or those for defined contribution plans apply. 1. Defined Benefit Plan A defined benefit plan is qualified under ERISA and the Code and provides a specific pre-determinable amount of benefits to a participant at that individual's projected date of retirement, which is usually age 65, which will continue for the employee's lifetime. Normally, the benefits are based on a formula that incorporates the participant's projected years of service and final average compensation Defined benefit plans under ERISA are required to bbe funded on an ongoing basis in accordance with actuarial principles enumerated in ERISA and the Code. The employer's contributions are to a “poo!” based upon actuarial considerations pertinent to the ‘employee “pool.” In most cases, these plans are “non- contributory”, meaning the employee does not make ‘contributions to the plan. A participant's benefits under 4 defined benefit plan are referred to as “accrued benefits.” A statement of the present value of a participant's accrued benefit in a defined benefit plan is merely a projection as of the present time of the participant's monthly pension benefit at normal retirement age. The accrued benefit is calculated on the basis of the participant’s present age, years of accredited service, and salary. Most defined benefit plans provide for early retirement prior to normal retirement age, with reduced payments established in tables or schedules, establishing discounts for different ages at early retirement, with the reduced payments made up with an early retirement subsidy, if offered by the plan. Internal Revenue Form 5500 can provide information of whether or not a plan’s funding levels, have been met, This is important in today’s economy with the fall of some major defined benefit plans and if the benefit plan has few participants. It is vital to check to be sure funding levels have been met or if there are any funding liabilities before advocating for a share of the benefit Form $500 could be extremely valuable in small plans, or where the spouse is also the plan administrator ofthe plan, such as in a small business Cash balance pension plans have become more popular among employers and are a form of defined benefit plan which provide each participant with hypothetical account. A contribution is made into the account, usually based on age or years of service with the employer. In that way, the plan looks very much like defined contribution plan, Remember that the investment risk is on the participant in @ defined contribution plan, but on remains on the employer in a cash balance pension plan. These plans will accept vision much like that of a defined contribution plan and will alow the non-employee spouse to obtain their money upon the presentation of a QDRO, much like a defined contribution plan. However, the plan’s rules should be read carefully prior to dividing the plan, as the plan's rules control. The model QDRO can lend important division information As to a defined benefit plan that has converted to ‘cash balance pension plan, ascertain whether there are two accounts or one. Some plans converted to a cash balance plan, and some plans terminated their defined benefit plan and then started a new cash balance pension plan. Ifthe latter, the participant could feasibly have two plan accounts, wherein two QDROs are necessary rather than one. 2. Defined Contribution Plan A plan qualified under ERISA and the Code that provides, for contributions directly to individual accounts established and maintained for each plan participant is a defined contribution plan. The contributions may consist of either employee or employer contributions, or both. The participant is generally entitled to receive the account balanceDivision of Retirement and Division Orders ____Chapter 27 (together with any interest accrued thereon as well as investment gains or losses) when the employee retires, or otherwise terminates employment with the company. Usually the benefit wil be in the form of a single-tife annuity or lump-sum payment. There are several types of defined contribution plans, including profit sharing plans, thrift plans, section 401(k) plans, retirement savings plans, stock bonus plans, and employee stock ‘ownership plans (ESOP’s). It is important to verify if the plan is in fact governed by ERISA, which would ‘mean it isa qualified plan. C. Defined Benefit Plan Division There are no statutory rules for determining the community and/or separate property interest in a defined benefit plan, and case law controls regarding ‘determining the character of such benefits 1. Characterization of Defined Benefit Plans Since 1977, an employee's separate interest, and the community's interest, in a defined benefit plan has been characterized based upon a time apportionment formula. The formula was first enunciated by the Texas Supreme Court in Taggart v. Taggart, 522 S.W.2d 422 (Tex. 1977) and the participant in such case was in pay status. This formula was further modified by Berry v: Berry, 647 S.W.2d 945 (Tex. 1983) for participants ‘who are not in pay status and the benefit is calculated as if the participant retired at the time of divorce as if the participant was eligible at that time. The Berry case set forth a formula commonly referred to as the “The Berry formula.” In Berry, the ‘Texas Supreme Court clarified that retirement benefits fare to be valued at the time of divorce, and the employee's benefit is apportioned between the employee spouse’s separate estate and the community estate by virtue ofthe following “Berry formula” ‘Number of months married and in the plan Number of months in the plan as of the date of divorce =X X is then multiplied by the benefit ar she rime of divorce This fraction yields the community estate's share of the value of the benefit and such fraction is to be applied as if the participant retired as of the date of divorce. Ik should be noted, and it is discussed in more detail infra, that the Berry formula is not applicable to the state plans in that such plans are hybrid plans and are not true defined benefit plans, 2. Early Retirement Subsidies and Cost of Living Adjustments Under many defined benefit plans, the normal retirement age is 65, but of course this varies from plan to plan. This means that an employee can retire at the plan's normal retirement age and receive his/her full unreduced accrued benefit. Generally, an accrued benefit can be calculated at any point during the employee’ employment. ‘The vast majority of defined benefit plans include carly retirement provisions of some sort that afford ‘employees the opportunity to rete before their normal retirement age, but with a reduction for early retirement, Remember, carly retirement subsidies were ‘meant as an enticement for the employee to retire early, not as bonus for an alternate payee to commence benefits early, Because alternate payees can commence their share of the benefits when the participant reaches the earliest retirement age, and before the Participant actually retires, the altemate payee can only receive his/her share of the benefits on an unsubsidized basis, which is the application of an carly retirement reduction. Because the early retirement subsidy is part and parcel of the participant's accrued benefit, it should be considered a community asset subject to division and consideration upon divorce. As a co-owner of the pension, the alternate payee should be entitled to receive a pro rata share of an early retirement subsidy of the participant. After al, if the plan does not reduce the participant's share of the pension upon early retirement, why should the altemate payee’s share of the pension be reduced? And, if an alternate payee’s portion of the pension is reduced for early retirement, then such reduction may be paid to the participant. The alternate payee will only receive their share of the early retirement subsidy to the extent awarded in the QDRO, therefore it must be in the QDRO for the alternate payee to be reimbursed by the early retirement subsidy should the alternate payee commence benefits with an early retirement reduction. Remember that an early retirement subsidy is only payable to the participant who retires before normal retirement age. If the participant waits until hisher normal retirement age to retire, then no early retirement subsidy will ever be paid. Further, in defined benefit plans, the benefit payable at normal retirement age (the “accrued ‘benefit’ is. life annuity based on the participant's life, This benefit can usually be paid early; however, when a benefit is commenced earlier than normal, the plan has a right to actuarially reduce the payment stream to account for the fact that it is anticipated to flow for a longer period of time. When this happens, the amount of each monthly payment due is reduced, but the value of the annuity remains actuarially equivalent to the normal retirement benefitDivision of Retirement and Division Orders Chapter 27 Example: A $1,000 per month single life annuity based on the participant's life starting Aa 65 is the approximate equivalent of a $500 per month life annuity starting at age 55. Both payment streams are of equal value, actuarially speaking Although plans have a right to make this adjustment, rot all do, Some encourage early retirement by providing that if a participant retires early, there will either be no actuarial reduction, or something less than a full reduction. Such plans are said to offer an early retirement subsidy, the cost of which is picked up by the employer as an additional funding liability. This subsidy is the difference in value between the value of | the early retirement benefit and the normal retirement, and can equal or even exceed the value of the normal retirement benefit itself, Because there is a quid pro quo for this subsidy, ©. giving up a good salary early, it does not become a part of a participant's accrued benefit unless and until the participant accepts early retirement, however itis part and parcel of the plan ‘Although a QDRO may divide the early retirement subsidy if it becomes payable, it may not provide for payment to be made before actual early Typically, this is handled with a provision stating that if the subsidy becomes payable, then the altemate payce’s payments will be increased by a pro rata share thereof, However, alternate payees should understand that if their awarded share has already been paid by the plan as a lump sum before the participant retires, the subsidy otherwise payable on that portion of the benefit will revert to the plan. And, if instead, the alternate payee has commenced their share of the benefits, then only the portion of the benefit remaining may be subsidized, rather than any retroactive application. Ifthe alternate payee’s attorney is unsure on this issue, asking the plan administrator will be wise. If such attomey cannot obtain the information, include the provision in the QDRO and make the plan instruct to remove it. At least then the alternate payee's attorey will have a clear ‘Accordingly, a QDRO for a plan that offers early retirement subsidy benefits should not require the award to be paid or commenced as soon as feasible after QDRO approval, as such will cause the QDRO not to qualify, but rather to simply award the alternate payee any early retirement subsidy based on their awarded portion of the benefit. In addition, some defined benefit plans also pay cost of living adjustments (“COLAS"), and some do not. These adjustments will only be paid on an alternate payee’s portion if provided for in the QDRO. D. Defined Contribution Plans 1. Applicable Statutory and Case Law Texas Family Code § 3.007 entitled “Property Interest in Certain Employee Benefits” contains a provision that authorizes tracing within a defined contribution plan as follows: “(©) The separate property interest of a spouse in a defined contribution retirement plan may be traced using the tracing and les that apply to a onretirement asset, [emphasis added) Under case law, an employee spouse's account balance in the employee's defined contribution plan on the date of marriage is separate property and the increase in the account balance between the date of marriage and the date of divorce is community property. Pelzig_. Berkebile, 931 S.W.2d 398 (Tex. App.—Corpus Chris [13* Dist.) 1996, writ ref'd). The subtraction method could be inherently unfair if there is separate stock, for example, that has increased in value and/or stock dividends were paid, The participant with separate property in their defined contribution plan should consider having the plan traced by a consulting expert to determine whether tracing or subtraction will yield the best result, Thus, if the participant cannot adequately trace the separate funds in the defined contribution plan, then the participant can use the safety net of mere subtraction. Many clients have loans against their retirement plans. Loans from retirement plans may not require the consent of the non-employee spouse, it just depends on the plan’s rules. Loans against retirement plans are paid back usually with payroll deductions, therefore all funds used to pay back the loan during marriage are community property, absent a premarital and/or partition agreement. Defined contribution plan loans may be in the form of a loan by the company, secured by the retirement plan account, or the employee may be borrowing his/her own funds from the retirement plan account. Further, the majority of the time the plan cannot look to anyone except the employee for payment, and the plan cannot accept funds from anyone except the employee. If an employee defaults on a retirement plan loan, the unpaid balance of the loan is treated as a distribution to the employee in the year of default. In addition, any interest on the loan is usually being paid by community property (payroll deductions) into the employee's retirement account, in that the «employee pays the interest into their own account, ifthe loan is against the participant's own plan benefits. Credit obtained by a spouse during marriage is community credit unless the lender agrees 0 lookDivision of Retirement and Division Orders Chapter 27 funds could be paid tothe participant with no chance to recapture them for the altemate payee. Thus, it cannot be stressed enough that the plan administrator should be notified immediately to make all necessary’ arrangements to ensure that amounts called for under the order are not paid out to the plan participant. If, within 18 months of the date the first payment from the Plan would be required to be made under the QDRO, the QDRO (or modification thereof) the plan determines the QDRO to be qualified, the plan administrator shall direct payment of the amounts, separately accounted for (including any interest eared thereon) to the person or persons entitled thereto. If within such 18-month period the plan administrator determines that the QDRO is not a qualified domestic relations order, or the issue as to ‘whether such QDRO is a qualified domestic relations order is not resolved, then the plan administrator shall direct payment of the amounts separately accounted for {including any interest earned thereon) to the person or persons who would have been entitled to such amounts if there had been no QDRO. Any determination that a QDRO is a qualified domestic relations order, which is made after the close of the 18-month period, can be applied prospectively only, 5 ol Info the Plan Under the Department of Labor’s Guidelines, the duties of the plan administrator are discussed. If these guidelines are made regulations, then attorneys will be able to discover the relevant information without the necessity of a release, subpoena, or dummy QDRO. Until then, the plans will usually ask for a release from the participant or a subpoena, even when submitting a signed order, declaring the alternate payee as the owner of @ portion of the plan. It is a good idea to go ahead and get a release signed, even if a motion to do so has tobe filed. The information must be released to a third party when the participant has authorized in writing the release of such information to the third party. ERISA Opinion Letter 79-821 (Nov. 21, 1979). VI. STATE GOVERNMENTAL PLANS T give credit in this section to Phil Phillips, my friend and colleague. I State Plans A. General Considerations for 1, State retirement systems are specifically excluded from the provisions of ERISA. However, Chapter 804, Subchapter A, Texas Government Code, provides anti-alienation provisions to these public retirement systems similar to ERISA and allows an assignment of a benefit to an alternate payee only by way of a qualified domestic relations order. (804,003(a)). If the retirement benefit is not 23 divided but is awarded 100% to the member, no QDRO is required, but the decree should be very specific in making the award, so that there is no question. The administrative head of a State retirement system or his/her designee, has exclusive authority to determine whether a domestic relations order is a “qualified domestic relations order". Such a determination may only be appealed to the board of trustees” of the System. (804,003(b)). A State retirement system will reject a DRO that requires the designation of a particular person as beneficiary in the event of the ‘member's death A State retirement system will reject a DRO that requires the member to select a particular benefit payment plan or option ‘Texas law does not require the division of a State retirement plan; however, the nature of the plans make them difficult to value for the purpose of “trading” assets All but one of the following State retirement systems plans require member contributions. Upon retirement, a member may choose 10 withdraw his or her contributions with interest, or receive monthly annuity payments. In some plans, a member may be able to take a partial lump-sum distribution and a reduced monthly annuity payment, The — amount of the _participant’s ‘contributions to the plan has little to do with the value of the plan, These are not defined contribution plans and the amount of the participant's contributions as reflected on the annual statement does not account for the employer's “matching” contributions, Although the Texas County and District Retirement System (TCDRS) and the Texas “Municipal Retirement System (TMRS) have ‘models that allow the award of a lump-sum amount, immediate lump-sum distributions are not allowed. If the participant terminates employment and elects to take a refund of hishher contributions, only then would a lump ‘sum be also payable to the altemate payee. Avoid making a specific lump sum award, since many State retirement plans, such as the Teachers Retirement System (TRS), won't accept a QDRO with a lump sum award. Except for a limited exception with the Teachers Retirement System, payments 10 the altemate payee will begin only when ‘payments begin to the participant.Division of Retirement and Division Orders ____ Chapter 27 B. Division of Plan and Alternative Formul 1. Accumulated Contributions Formula_vs. Credited Service Formula TMRS and TCDRS provide nv methods of calculating the benefit to be awarded. Even if the participant is not retired at the time of the divorce, both methods use the Taggart formula (benefit divided at date of benefit commencement) instead of the Berry formula (benefit divided at time of divorce). A. reason for this is due to how these plans pay benefits. Whereas, TRS has a set formula for calculating benefits (2.3% X No. of Yrs. of Service X High-5 Yrs. Salary / 12), TMRS and TCDRS do not. Instead, ‘TMRS and TCDRS purchase an annuity at the time of benefit commencement, using the participant's contributions andthe employer's matching funds. Since market conditions atthe time of purchase can be very different from those at the time of divorce, these plans can only roughly estimate the benefit payments atthe time of divorce, and don't fee! this is sufficiently precise for the purposes of a QDRO. a, Accumulated Contributions Formula This method divides benefits by calculating the amount of a participant's deposits (contributions) and interest accumulated during the marriage and dividing that by the participant's total deposits and interest at the time of benefit commencement. Use of this method will usually result in a larger award to the altemate payee when there was considerable service prior to marriage, since the early-careet deposits are usually smaller than later-career. ‘The formula used by the plans is (assuming a $0% division) 4X Total Deposits & Interest = Divorce Factor Divoree Factor X Benefit Alternate Payee's Award Payable = Assume a participant with $45,000 in deposits and interest during the marriage and a total of $60,000 at the time of retirement, with a monthly benefit of $3,000. The formula would be: “4X $45,000860,000 = 375 $3,000 per month X 375 = $1,125 per ‘month for the alternate payee b. Credited Service Formula ‘This method divides benefits by comparing the number of months of covered employment during ‘marriage with the member's total covered employment at time of retirement or refund of deposits. It assumes that each month of credited service has the same value as every other month, which is usually not accurate. Use of this method will usually result in a smaller award to the altemate payee when there was considerable service prior to marriage, compared to use of the Accumulated Contributions formula ‘The formula used by the plans is (assuming a 50% division) ‘AX Credited Service During Marriage ‘Total Credited Service = Divorce Factor Divorce Factor X Benefit Alternate Payee's Award Payable = Assume a participant with 120 months of credited service during the marriage and a total of 150 months of credited service at the time of retirement, with a ‘monthly benefit of $3,000. The formula would be: ‘4X 120150=.4 $3,000 per month X 4 = $1,200 per month forthe alternate payee 2. Deciding Which Formula to Use If the contribution information and credited service information is available, counsel should make the calculations to determine which formula produces a Divorce Factor that most benefits their client, and attempt to have that used in the QDRO, Although use of the Accumulated Contributions formula appears to provide a more accurate division of| the benefits, be aware that an appellate court of this State has never approved the use ofa formula that does not follow a time apportionment scheme such as the Credited Service formula above. For participants that are retired at the time of divoree, Taggart v. Taggart, $52 S.W.2d 422 (Tex. 1977) is still controlling, and for those not retired at the time of divorce, Berry v. Berry, 647 S.W.2d 945 (Tex. 1983) is controlling. In Berry, the Court had an opportunity to totally overrule Taggart and get away from a time apportionment method, but declined to do so, and simply revise the time apportionment formula. That decision was cited in Shanks v. Treadway, 110 S.W.3d 444 (Tex. 2003), even though the Court recognized the “serious concerns” that had arisen regarding the time apportionment formula in certain cases. Finally, in Humble v. Humble, 805 S.W.24 558 (Tex. App. Beaumont 1991, writ denied), the appellate court confirmed the trial courts rejection of the use of an acerued benefit method (which is, similar to the Accumulated Contributions formula