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Understanding Passive Growths

The account balance of a defined contribution plan is the present value.  There are many types of these "What you see is what you get" type plans known variously by names including 401 (k)plans, profit sharing plans, thrift and savings plans, employee stock ownership plans (ESOPs), individual retirement accounts (IRAs), Keoghs (HR 10), money purchase plans, stock bonus, target plans, simplified employee pension plans as well as 403(b)(7)s.  The value of any of these plans is the amount contributed by the employee and/or employer plus any growth on those contributions. 

The plans differ from a savings account in that they are usually based on pre-tax dollars.   Significant taxes and penalties will be incurred if any or all funds are withdrawn early without being "rolled over" into another tax deferred type of account.  The use of a Qualified Domestic Relations Order (QDRO) may help reduce or eliminate the tax and liquidity problems when the ownership of the account is split between the participant and non-participant. As a property settlement, a QDRO allows for a transfer to the non-participant without incurring the 10% early distribution penalty even if the money is not rolled over into a retirement account for the non-participant. If the funds are not rolled over into a retirement account for the non-participant, the distribution would be subject to current income taxes.  A direct rollover to the non-participant's retirement account would avoid all current taxes. When money is withdrawn from the non-participant's retirement account, it is taxed as ordinary income. 

In a defined contribution plan, any employee leaving the plan prior to becoming vested in the employer contribution forfeits those employer contributions to the remaining members of the plan.  Employee contributions are not subject to forfeiture, one is always 100% vested in their own contributions, subject, of course, to any gains or losses. For purposes of our evaluations we consider forfeitures to be additional contributions. 

Determining the passive growth then becomes a two-step process. First, we determine the account balance at the date of marriage. If the date of marriage coincides with the plan statement date, the balance is clearly ascertained directly from the statement.  For other dates, we simply interpolate between the statement preceding the date of marriage and the statement following the date of marriage. Second, the experience (growth or loss) of the non-marital asset and the marital assets must then be determined. We then apportion the experience to the non-marital and the marital portions for each period of time based on the relative dollar amounts. We refer to the calculation method used to apportion the experience as the Mid-Period Proportional Method.  As implied by the name, this method assumes all activity occurs at the middle of each period, which is equivalent to assuming all activity occurs uniformly throughout said period. 

This is an inferential type of accounting that allows calculation of growth on the relative marital and non-marital account balances based on the total assets of the account rather than tracking individual holdings. The strength of our calculation is that it makes clear, reasonable assumptions regarding the growth of the non-marital and marital components based on the investment experience of the total plan and eliminates consideration of exact asset allocations and exchanges, generally without regard to the original timing of any purchase or sale of specific holdings in the account.

DISCUSSION & CASE LAW HIGHLIGHTS

Discussion of Issue: The value of a defined contribution plan such as a profit sharing, 401 K, or ESOP plan or the like is straightforward. The account balance at any given time represents the best measure of value because each participant has a separate account into which all contributions are deposited. The participant, of course, shoulders all investment risk and frequently participates in the investment choices. The value of a stock and/or bond portfolio may fluctuate dramatically while fixed income choices reduce that volatility. Problems crop up when the participant joins the plan before the marriage. In that case, the account balance at the time of the marriage and its growth are non-marital assets and should be subtracted from the current present value. This is not a settled issue nationally.

National Cases

Streza v. Streza, 2006-Ohio-1315. Separate property remains separate property and all growth on that property remains separate only if the owner can demonstrate the facts of that property. It is the burden of the owner to prove the existence and value of the separate property being claimed. 

West v. West, 2002-Ohio-1118, 9th Dist. 01CA0045. Property acquired and held during the marriage is deemed to be marital, except if it can be proved that the property was acquired by reason of a separate property situation. It is the burden of the party claiming the separate property to prove that the asset in question should be deemed a separate interest. 

Barkley v. Barkley (1997)119 Ohio App. 3d 155, 694 N.E.2d 989. The pre-marital account balance as well as the passive increase in value in a defined contribution plan is non-marital, separate property for the participant. 

Mann v. Mann (1996) 22 Va. App. 459,470 S.E.2d 605. Passive growth on a defined contribution plan is separate property. 

Maslen v. Maslen (1991)121 Idaho 85, 822 P.2d 982.  The plan participant wanted the marital portion determined by using coverture, i.e. use the ratio of the time the pension benefits were acquired while married to the total time the benefits were acquired. The trial court did not agree. Instead, they subtracted the account balance on the date of marriage from the value at the time of divorce saying the difference between the totals was the portion of the pension earned during the marriage.  Thus the court ruled all contributions and all interest increases (on both marital and non-marital portions!) that took place during the marriage were marital. 

Kanta v. Kanta (S.D. 1991) 479 N.W.2d 505 Plan participant's expert reduced the account balance of the defined contribution plan from $40,492 to less than $10,000 saying it was necessary to discount the value to present value because it accumulated no interest and was not immediately accessible. Non-participant spouse's expert noted that if the participant were to cease his employment at that time he would receive the $40,492 value. The South Dakota Supreme Court agreed that to value the account at less than contributions would be "unjust" and that the account would continue to grow through additional contributions over the years. 

Griffiths v. Griffiths (Fla. DCA 1990) 563 S, 2d 773 The Florida Court ruled that it was an error to consider all accumulations in the marriage as marital property when a portion of the accumulations were attributable to contributions made before the marriage. In re Marriage of Benz (1988) 165 Ill. App. 3d 273, 518 NE2d 90 Several alternative methods were presented for separating the marital portion from the non-marital portion of a defined contribution plan without approaching the plan for specific information. First, the accumulations during the marriage should be allocated in the same ratio as the amount contributed during the marriage bears to the total amount of contributions. Second, the marital accumulations would be allocated using the coverture fraction of time in plan while married over time in plan. Both of these systems can be used for advocacy reports because they are "guesstimates" which may or may not be accurate. 

Bettinger v. Bettinger
(W. Va. 1990) 396 S.E. 709 in which the West Virginia Supreme Court declared that "the valuation for equitable distribution purposes of a vested defined contribution plan is the present actual value of the contributions made and the accumulated earnings thereon." at 718.

COMPARISON OF ANALYSIS METHODS

Mid-Period Proportional Method

In this method the growth is calculated for the total account for each period and apportioned to the marital and non-marital property based on the relative proportion of each piece to the total account. These relative proportions are calculated assuming uniform activity throughout that period; this is equivalent to assuming that all activity occurs at the middle of the period. The total growth is apportioned based on the allocation of the marital and non-marital assets as of the middle of the current period. 

The total growth for any period is calculated by subtracting the ending balance from the beginning balance, then subtracting all money going into the account and adding back in all money coming out of the account for that period.  This is the increase in the account due to change in asset value, interest and dividends  as distinguished from changes related to initiatives by the participant, in other words, the passive growth of the account. All additions or subtractions not relating to experience of the assets -  contributions, loans, loan payments, withdrawals, etc., which are initiated by the participant are considered as the activity and are determined to be either marital or non-marital in nature, in part or in total. Fees are considered as part of the experience/passive growth of the asset holdings.

The marital calculation begins with the determination of the ending marital balance from the previous period. Half of the net marital activity for the current period is then added. Divide that number by the ending total account balance from the previous period plus half of the net total activity for the current period. Therefore, this proportion represents the percentage of the account that is marital at the mid-point of the period. Multiplying the total dollars of growth by this percentage, representing the marital component of the account, provides the dollars of marital growth to be allotted to the marital running balance.

The same calculations are made regarding non-marital assets. Based on the assumptions, this generates accurate marital and non-marital balances as of any end of period date. However, they are balances as of that specific date, only, and not as of the end of the period of the most recent statement. 

Please refer to the example later in this section.

Accounting Growth Method

In this method the growth is calculated for the total account for each period and expressed then as a growth percentage for the total account. This growth percentage is then applied to the preceding marital and non-marital balance and activity. This method assumes that the net activity for each period occurs on the first day of the period. 

The total growth for any period is calculated by subtracting the ending balance from the beginning balance, then subtracting all money going into the account and adding back in all money coming out of the account for that period. This is the increase in the account due to change in asset value, interest and dividends, as distinguished from changes related to initiatives by the participant, in other words, the passive growth of the account. All additions or subtractions not relating to experience of the assets -  contributions, loans, loan payments, withdrawals, etc., which are initiated by the participant are considered as the activity and are determined to be either marital or non-marital in nature, in part or in total. Fees are considered as part of the experience/passive growth of the asset holdings.

The marital calculation begins with the determination of the ending marital balance from the previous period. The net marital activity for the current period is then added. These marital assets are then multiplied by the growth percentage and tracked as a running number representing the marital component of the account. 

The same calculations are made regarding non-marital assets. This generates approximate marital and non-marital balances as of any end of period date. However, the running allotted values do not represent the actual apportioned values due to rounding and the weighting of the activity versus the timing of the actual event. Because we are multiplying two, sometimes rather large, balances by a growth rate, usually the marital and non-marital balances do not sum up to the exact account balance. As a result, the balances must be adjusted, via a proportion, up or down to yield the true result of the analysis. Therefore, based on the assumptions, the stated allocation is valid only for the date of the adjustment; the values in the calculation history are tentative pending the final adjustment. 

Please refer to the example later in this section.

Example of Mid-Period Proportional Method

Balance
Contributions
Total Growth
Marital
Non-marital
Previous
$76,000
$21,000
$55,000
Current
$85,000
$1,250
$7,750

Marital Proportion:

MathJax example

$ 21 , 000 + ( 0.5 × $ 1 , 250 ) $ 76 , 000 + ( 0.5 × $ 1 , 250 ) = 28.22 %

Marital Growth Dollars:

MathJax example

$ 7 , 750 × 28.22 % = $ 2 , 187.05

Running Marital Balance:

MathJax example

$ 21 , 000 + $ 1 , 250 + $ 2 , 187.05 = $ 24 , 437.05

Example of Accounting Growth Method

Balance
Contributions
Total Growth
Marital
Non-marital
Previous
$76,000
$21,000
$55,000
Current
$85,000
$1,250
$7,750

Growth Rate:

MathJax example

$ 7 , 750 $ 76 , 000 = 10.20 %

Marital Growth Dollars:

MathJax example

0.1020 × $ 21 , 000 = $ 2 , 142

Running Marital Balance:

MathJax example

( $ 21 , 000 + $ 1 , 250 ) × 1.1020 = $ 24 , 519.50

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