Attorney s Guide to Dealing with Oregon PERS in Divorce By David Gault, CPA & QDRO Specialist Presented in a CLE Session for Deschutes County attorneys held on June 3, 2016 in Bend, Oregon. Prepared and presented by David Gault, CPA & QDRO Specialist, of Jones & Roth CPAs and Business Advisors. Session Sponsor: Stahancyk, Kent, & Hook, P.C. Course Scope and Limitations This course of instruction is not intended to cover every conceivable issue that might arise when assigning a portion of a PERS member s benefits to the non-member spouse. The materials first provide background information to the reader regarding the division of retirement plan benefits in general and then finishes with instruction on specific application to PERS, including discussion of several important choices to be made that can substantially affect the quality of the outcome to your client.
DISCUSSION OUTLINE 1. The proper methods of dividing Oregon PERS accounts is an important subject for family law attorneys to understand well, and for two reasons: First, the size of the asset is usually quite substantial in relation to the other items in the inventory of marital property. Second, the potential for error is very much present because the path to correct treatment can be counterintuitive. 2. As PERS has evolved and changed over the years, the way attorneys must deal with dividing PERS accounts has also changed. Following the same methods used only a few years ago can lead to serious error. 3. PERS benefits (whether future or currently in pay status) represent property subject to consideration in property settlement. Contrary to the perceptions of some, the income stream of a PERS retiree does represent property potentially subject to division. 4. Settlement can deal with PERS benefits in one of two ways: A. Valuation and offset. B. Divide and assign using a Domestic Relations Order (DRO) C. If dividing, either the General Judgment (GJ) or a Supplemental Judgment can constitute the DRO. If using the GJ, care must be taken to make it sure contains all of the same content that a Supplemental Judgment would contain. D. PERS now requires the attachment to the operative judgment of specified forms provided by PERS. Those must be attached to the operative judgment before it goes to court. If a Supplemental Judgment is anticipated, the PERS forms do not belong with the GJ. 5. Understanding divisions of PERS benefits is aided by having some basic knowledge regarding the nature of retirement plans in general and approaches to their division in divorce. A. Retirement plans fall into two broad classifications: a. Defined contribution plans b. Defined benefit plans c. PERS has both for members actively employed after 2003 2
B. Defined contribution plans: a. Composed of individual participant accounts carrying an account balance, which is often made up of a variety of specific investment sub-accounts. A classic example is a 401(k) plan. b. The overall account balance represents the value. c. In most cases, an award to ex-spouse of any portion can be transferred out using a Supplemental Judgment known as a Qualified Domestic Relations Order (QDRO). d. The marital estate normally includes only the marital portion, the portion that arose during the marriage. e. Quantifying the marital portion requires a choice between what is termed passive growth inclusion and passive growth exclusion. Question: Is the investment growth occurring during the marriage on the Plan Participant s pre-marital balance to be treated as marital? f. If adopting passive growth inclusion, the calculation of the marital portion is as simple as subtracting the balance at date of marriage from the balance at date of separation or divorce. g. Applying passive growth exclusion is more challenging. Plan administrators are often unwilling to undertake the sometimes daunting task of computing the growth on the pre-marital balance. So if the plan participant spouse is intent on not having to share with the other spouse the investment income on his pre-marital balance that accumulated during the marriage, the services of an accountant may need to be engaged. C. Defined benefit plans: a. Participants do not usually have individual accounts that carry balances. b. Instead, participants have a contractual right to a future life-time annuity, measured by what is called an accrued benefit, which is tracked in the plan for each plan participant. c. There are two broad categories of DB plans based on the Plan s method of accruing each participant s future monthly benefit: 3
i. Final pay plans, commonly appearing in the corporate world and government settings ii. Unit benefit plans, commonly appearing in the world of trade unions d. With final pay plans, the monthly retirement benefit is derived by a formula that takes in to account compensation level and years of service. e. The most common benefit formula in final pay plans involves applying a factor (usually in the 1% to 2% range) to the average of the employee s highest three years compensation and then multiplying by total years of service. Example: If I have averaged $60,000 of annual compensation during my three highest paid years, and the formula uses a factor of 1.5%, then each year of service generates an annual pension of $900. So if I had 30 years of service, my annual pension would come to $27,000, and my monthly benefit would be $2,250. f. The fact that each year of service in a final pay plan will eventually be weighted the same, and that the benefit associated with the marriage years cannot be determined until the compensation component and the total years of service are known (both at retirement time), all suggests that for final pay plans one should not look at where the benefit stands at the date of divorce. The true contribution of the marriage years to the benefit paid at retirement can only be measured at retirement. Freezing the value of the pension at date of divorce denies the assigned interest the growth in value anticipated by the Plan s benefit formula. Doing so would be somewhat comparable to dividing a 401(k) balance at date of divorce, but then shifting the future investment earnings on the assigned account back to the plan participant. g. In final pay plans a fair division would treat the marital years the same for both parties. This can only be done by using what is called the coverture method of dividing a pension. In the coverture method the non-participant spouse is awarded a percent (usually 50) of the marital portion of the full final pension at retirement time by applying a marriage fraction. The numerator of the fraction is the number of years of benefit service during the marriage and the denominator is the total number of years of benefit service at retirement. Using this method does not result, as some people mistakenly think, in the former spouse sharing in benefits earned by the participant spouse in post-marriage years. h. The coverture method is firmly embraced by Oregon case law in cases such as Kiser, Stokes, and others. Careful language is needed in the General Judgment to insure that the coverture method will be utilized. QDRO specialists are often hamstrung by language in the GJ that limits the nonparticipant spouse to half of the pension benefit as it stood at date of divorce. 4
i. With unit benefit plans (which might also be labeled union style plans), the accruing retirement benefit grows by contractually set additions hour by hour of service. The contracts between employer trade groups and trade unions spell out the arrangement. j. With this type of plan there is a better argument that division of the benefit as it stands at date of divorce represents an accurate reflection of the size of benefit earned during the marriage. Case law in Oregon, however, (as far as this author knows) has not caught up with this distinction between what is fair in a final pay plan and what is fair in a unit benefit plan. Some experts believe that case law in Oregon supports only the coverture method. It appears, however, that this may well stem from the fact that the Oregon Court of Appeals has not been asked to address this distinction. This author believes that if the Court is ever asked to rule on the question, that it will likely not require the coverture method for unit benefit plans. Also keep in mind that any method of division is acceptable if no one challenges the method you have selected. D. Implications for wording the General Judgment: 1. The differing nature of defined contribution plans versus defined benefit plans behooves the family law attorney to carefully word his/her Judgment to fit the situation. Too often we see meaningless provisions because they were applicable only to the other category of plan. 2. If you have a define contribution plan, specify the amount or percentage of the award, along with an effective date for the assignment. The effective date can be in the past, but if you go too far back in time there may be a reluctance on the part of the plan administer to accept a QDRO. Practice varies widely among plans. 3. If you have a traditional defined benefit plan, do not make reference to an account balance and do not make reference to investment earnings and losses from a cited date. A traditional DB plan has neither of these. 4. For a defined benefit plan, make clear whether you are dividing the accrued benefit as it stands at date of divorce versus utilizing the coverture method (also sometimes referred to as the time rule ) to apportion the pension at the retirement time by applying a marriage fraction. 5. An example of the language utilizing the coverture method is as follows: Petitioner is hereby awarded 50% of the marital portion of Respondent s pension under the Weyerhaeuser Pension Plan using the time rule. The marital portion shall be determined by applying a marriage fraction to the fully-matured benefit at retirement time. 5
PERS DIVISIONS SPECIFICALLY WHAT TO DO AND WHAT ISSUES TO CONSIDER 1. First obtain a copy of the Member s most recent annual statement which arrives each May covering the preceding calendar year: A. Provides the membership start date, which in turn may indicate that a non-marital portion must be dealt with. B. For Tier I and Tier 2 members, the statement reports the member account balance. That balance does not represent the value of the underlying pension. The pension may easily be worth five or ten times the balance in the account. C. For OPSRP members (those employees hired after August 15, 2003), reports the accumulated years and months of benefit accruals. Unlike Tier 1 and Tier 2 members, OPSRP members have no member account. D. For all members who were actively employed after 2003, reports the beginning and ending account balance of the IAP account. 2. Next, consider the choice between assigning a portion by DRO and retention by the Member after valuation and offset. 3. If opting for retention and offset, engage the services of a valuation expert, who can be either an actuary or certain qualified CPAs who specialize in pension valuation. 4. If dividing using a DRO, consider with respect to the pension account a choice between an Upfront Division and a Deferred Division. This choice is relevant only to Tier I and Tier 2 members because they are the only ones with an account balance to divide at time of divorce. For OPSRP members, a deferred division is the only choice available. 5. When a member retires, his/her benefit is calculated under both the money match method and the full formula method. The method deriving the larger benefit is automatically used. 6. An upfront division immediately moves a portion of the Member s account balance into a separate account set up in the name of the non-member spouse. It remains there and grows with investment gains until the Member s earliest eligible retirement date. Benefits for the nonmember spouse are then determined restricted to the money match method. This means that if the Member ends up retiring under full formula, the non-member spouse who accepted an upfront division might well have settled for a smaller benefit than would have resulted under a deferred division. 6
7. A deferred division essentially represents use of the time rule under the coverture method. It puts in place a pending order to the PERS administrator to allocate between the parties at retirement time the full amount of the retirement benefit while applying the marriage fraction, and regardless of whether the Member s benefit was derived under the money match or the full formula method. 8. Keep in mind that an upfront division limits the non-member spouse to a benefit derived under the money match method. The deferred division, in contrast, applies a time rule proration to the Member s final benefit. This means that it is in each party s interest to make a correct forecast as to which method the Member will actually retire under, the money match or the full formula. If the Member retires under money match, the Non-Member will fare best under an upfront division, while the Member fares less well. If the member retires under full formula, the Non-Member will fare best under a deferred division, while the Member fare less well. The choice between upfront and deferred affects the parties in opposite ways. Most Tier 2 members and more and more Tier 1 members will retire under the full formula and not the money match. This means that, in most cases, the non-member spouse will fare better under a deferred division. But if there is a surprise and the Member actually retires under the money match, then an upfront division would have been a better choice for the non-member spouse. 9. What does Oregon Case Law say about which method should be used? Cases such as Kiser and Stokes seem to say that when a plan operates as a defined benefit plan, and particularly one of a final pay nature, which PERS does anytime the final benefit is determined pursuant to the full formula, then the coverture method is to be used So when full formula determines the Member s benefit at retirement, the law appears to dictate a deferred division. But if the money match prevails as the operative method in establishing the Member s pension, PERS Tier One and Tier Two accounts are now taking on the nature of a defined contribution plan, where it is an account balance, not a formula, that derives the retirement benefit. Suddenly, the PERS pension becomes similar to a 401(k) plan, and an upfront division becomes the appropriate division method. 7
DIVIDING THE IAP ACCOUNT 1. Unlike the pension account, the IAP account represents an immediate source of accessible funds. Actually, the assigned portion of the member pension account can be accessed by the non-member spouse in an upfront division, but only with such horrendous forfeiture as to make it prohibitive. Under the pension program the money match is forfeited when the member account balance is withdrawn prior to retirement. With the IAP the awarded portion can be withdrawn or rolled over tax-deferred into an IRA or other defined contribution retirement plan account. 2. The same document that awards the non-member spouse a portion of the pension also addresses the disposition of the IAP account. If there is to be a supplemental judgment (DRO) to be sent to PERS, then that document will be the operative order for both the pension account and the IAP account. The General Judgment still needs to recite the generalities of the award with respect to both the pension and the IAP and provide that a DRO is to follow. If the General Judgment alone is what you are sending to PERS, the both accounts are awarded through it. 3. The IAP account is simply a defined contribution account carrying an account balance. Accordingly, its division is handled in the same way as the division of other defined contribution accounts is handled, but with one exception. While you still recite an award of a specific dollar amount or percentage, the effective date PERS is to segregate the account must be a December 31. 4. So how do you handle it when the desired property settlement date does not coincide with year end? The answer is that you can create a de facto division at any date by awarding a dollar amount equaling the appropriate portion of the IAP account balance as it stands on the desired date. The assignment instruction needs to establish the award date as being the preceding December 31, creating a temporary unequal division on that date. But the monthly contributions flowing in following that December 31 assignment date will all be attributed to the member s separate account. By the time the target division date is reached in the current year the two accounts will have equalized. 5. The IAP account may not be entirely marital, and when it is not, the choice between passive growth inclusion versus passive growth exclusion comes into play. 6. Sometimes divorcing parties will agree to value and offset the pension account with other assets, while assigning half or some portion of the IAP account to the non-member spouse. 7. If using any pre-tax retirement account to offset other assets in the property division that do not carry the burden of a future income tax, be sure to tax-adjust the comparative values. ABOUT THE AUTHOR David Gault, CPA, CDFA, & QDRO Specialist, is a retired shareholder and now part-time Senior Manager with Jones & Roth, PC based in their Eugene office. David primarily drafts QDROs for family law attorneys and has been published on a number of occasions in the OSB Family Law Newsletter. He can be reached at 541-687-2320 or davidg@jrcpa.com. 8