Understanding the portions of a defined contribution plan.
By Rick Johnson (Texas)
To Read Part 1 Click Here
Defined contribution plans increase in value in three (3) 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.
Rick Johnson operates QDRO Services, LLC in The Woodlands, Texas. The company was formed in early 1996 for the purpose of assisting attorneys and their clients with the division of retirement benefits and a QDRO solution when it is necessary.