QDRO's

There are many ways to define an alternate payee's benefits under a defined benefit pension plan. Some attorneys use a percentage of the participant's accrued benefit at the time of divorce. Others include a fixed dollar assignment of benefits. In any event, you should always base the alternate payee's share of the benefits on the participant's "accrued benefit." Because there are typically no individual accounts maintained for plan participants under a defined benefit pension plan, you should never refer to a participant's account balance or investment gains/losses when drafting the QDRO.

Generally, a participant's accrued benefit can be calculated at any point in time during his/her working career. A participant's accrued benefit is usually payable in the form of a monthly annuity for life commencing at his/her normal retirement age (usually age 65). In other words, if the participant is age 35 at his divorce date, it is possible for the plan administrator to calculate his accrued benefit as of such date, but this amount would generally not become payable to the participant (or the alternate payee) on an unreduced basis until he/she attains the plan's normal retirement age.

Many attorneys that represent the plan participant attempt to draft a QDRO that freezes the alternate payee's share of the benefit at 50% of the participant's accrued benefit under the plan as of the date of divorce. While a plan administrator will certainly accept this language (and may even recommend it in one of their model QDROs), it can be extremely hazardous to the financial health of the alternate payee. This is another good reason for an attorney that represents the alternate payee not to arbitrarily use the company's model QDRO. A company provides model QDROs for one reason only--to expedite the QDRO review process. And from a paternalistic standpoint, they do not really care whether the alternate payee's rights are secured in an "equitable" manner. It's alright to use some of the boilerplate nonsubstantive language from a model QDRO, but be sure to compliment it with language that will properly secure the benefits for your client.

The "Coverture Approach": To best represent the rights of your client, the nonparticipant spouse, you should utilize the "Coverture Approach" for dividing benefits under a defined benefit pension plan. Under this coverture approach, the alternate payee's share of the benefit is not based on the participant's accrued benefit under the plan at the date of divorce. Rather, the alternate payee's share is based on the participant's benefit at the participant's date of retirement, when it is, of course, highest. However, the alternate payee does not simply receive 50% of the participant's ultimate retirement benefit. Once the participant's final benefit is calculated at retirement, the marital portion is then determined by multiplying the accrued benefit by a coverture fraction, the numerator of which is equal to the participant's years of service under the plan that were earned during the marriage and the denominator of which is equal to the participant's total service under the plan as of his date of retirement. The alternate payee would then be entitled to 50% of the marital portion of the ultimate pension.

The use of the coverture approach is the only way to provide the alternate payee with inflationary protection on her ownership share of the pension. Under a QDRO, the numerator of the coverture fraction remains constant. It always represents the number of years of service earned under the plan by the participant while married. Remember, it is not a measurement of the duration of the marriage, but rather the years of service earned by the participant during the marriage. Therefore, if the participant accrued ten years of service during a thirty year marriage, the numerator would equal ten years.

The denominator of the coverture fraction represents all of the participant's years of service at retirement. Therefore, as the participant continues to earn future years of credited service after the divorce, the denominator continues to grow by one each year. In reality, as the denominator grows by one each year, the percentage share of the alternate payee's pension (ie: the coverture fraction) decreases. But this ever-decreasing coverture fraction is applied to a larger pension as the participant's accrued benefit continues to grow. In essence, with each passing year after the divorce, the alternate payee is earning a smaller percentage of a larger pie. This is how the alternate payee receives his/her inflationary protection under a pension plan.

This coverture approach is widely recommended as the only means of providing inflationary protection for an alternate payee under a defined benefit pension plan. In 1990, the Supreme Court of Ohio in the case of Hoyt v. Hoyt, 53 Ohio St. 3d 177, 559 N.E. 2d 1292 (1990), held that:

"In determining the proportionality of the pension or retirement benefits, the nonemployed spouse, in most instances, is only entitled to share in the actual marital asset. The value of this asset would be determined by computing the ratio of the number of years of employment of the employed spouse during the marriage to the total years of his or her employment."

With respect to addressing the alternate payee's coownership interest in the participant's pension utilizing the coverture approach, the Ohio Appellate Court said it best in Layne v. Layne, 83 Ohio App.3d 559, 615 N.E.2d 332 (1992):

"Because the ultimate value of a pension benefit, and of the respective shares of the spouses, increases with the number of years of service credit, an argument is frequently made that a former spouse is unjustly enriched when the value of his or her share is increased by post-divorce participation in a plan by the other spouse...

... a retirement plan is an investment made by both spouses during marriage to provide for their later years. They anticipate that the value of the investment will increase with time. At divorce, each spouse is entitled to the value of his or her investment. When the investment has not yet matured, each is entitled to its value at maturity in proportion to the years of marriage. The nonemployed former spouse is not entitled to share in the direct contributions made by the participant former spouse after divorce. However, the nonemployed former spouse is entitled to the benefit of any increase in the value of his or her unmatured proportionate share after divorce attributable to the continued participation of the other spouse in the retirement plan. That increase was contemplated when the investment was made. It would be inequitable to deprive the owner of its value. So long as each former spouse is limited to his or her proportionate right to share, there is neither unjust enrichment of the nonparticipant nor an inequitable deprivation of his or her rights." at 567

In viewing the nonparticipant as a co-owner of the pension, the Layne court logically found that the co-owner of an asset must be allowed to share in the inevitable growth of that asset. This perspective was, of course, in marked contrast to the trial court which froze the pension as of the date of the divorce. This would amount to freezing the nonparticipant's share of a defined contribution plan at a current dollar figure and then insisting that the amount would remain the same no matter when it was distributed. To do so would deprive the nonparticipant of the passive growth on their marital share of the account. A similar situation crops up with defined benefit plans when the nonparticipant spouse is "frozen out" from receiving the natural (and funded!) growth in the plan.

Recognizing "Bad-Coverture"

Quite often, it is the intent of the parties and the attorneys to utilize the traditional coverture approach, but they are not sure how to state it properly in the QDRO. As you know, the coverture approach bases the alternate payee's share of the benefits on the participant's pension at retirement. This accrued benefit is then multiplied by a ratio of the participant's years of service earned during the marriage divided by his total years of service at retirement. When using coverture, there are essentially three problem areas which could lead to an unintended result for the parties or a rejected QDRO:

1. The date of the accrued benefit calculation and the denominator of the coverture fraction must always tie into the same assignment date. For example, it's proper to state that the alternate payee's share of the benefits is based on the participant's accrued benefit at retirement when using coverture, but you must also be sure that the denominator of the coverture fraction represents the participant's years of service at retirement also. It would be improper to base the alternate payee's share of the pension on the participant's accrued benefit at retirement, but base the denominator of the coverture fraction on his or her years of service at the date of divorce. This apples and oranges comparison would not make mathematical sense.

2. If the QDRO permits the alternate payee to commence his or her share of the benefits on or after the participant's earliest retirement age, whether the participant retires or not, then the coverture formula should also include language which bases both the participant's accrued benefit and the denominator of the coverture fraction "as of the earlier to occur of his or her date of retirement or the alternate payee's elected benefit commencement date." Many coverture-based QDROs are rejected because attorneys attempt to base the alternate payee's share of the benefits on the participant's accrued benefit and years of service "at retirement", yet the QDRO allows the alternate payee to commence his or her share of the benefits before the participant even retires. This conflict can be avoided simply by including the "earlier to occur" language in the formula for both the calculation of the participant's accrued benefit and the denominator of the coverture fraction. In effect, both the accrued benefit and the denominator of the coverture fraction must not only tie into the same date, but must also always tie into the alternate payee's elected benefit commencement date.

3. The numerator of the coverture fraction should always be equal to the number of months or years of service earned by the participant during the marriage, and not simply the duration of the marriage. Many attorneys make this mistake. For example, if the QDRO stated that the numerator was equal to the duration of the parties' marriage, the alternate payee's share of the benefits could be significantly overstated if the participant began his employment after his marriage to the former spouse. If the marriage lasted for 15 years, but the participant only worked at the company for 8 of those years, the numerator of the coverture fraction clearly should equal 8 years and not 15.

Watch Out for a Coverture Look-alike

It is possible that the QDRO incorporates a coverture-like formula, but not the traditional coverture approach. Some attorneys who do not understand the mechanics of the coverture formula may be mislead by opposing counsel into believing that coverture was used, but really, the alternate payee's share of the benefits is frozen at divorce. This happens when pseudo-coverture-formula language is used, but rather than basing the accrued benefit and denominator of the coverture fraction on the participant's accrued benefit at retirement, the sly attorney for the plan participant will base the accrued benefit and the denominator as of the parties' date of divorce. When used, it looks a lot like the traditional coverture formula, but instead, it can result in an inequitable and understated amount for the alternate payee. I refer to this bastardized coverture approach as the "frozen coverture" approach. Effectively, the numerator does represent the years of service earned during the marriage, as it properly should. But it's based on the pension at divorce rather than the pension at retirement. It's a win-win for the participant, because it excludes service earned before the marriage, yet does not provide the alternate payee with any inflationary protection for periods after the divorce, as is the case with the traditional coverture approach. If the plan administrator reviews a QDRO that utilizes this frozen coverture approach, it is still an acceptable form of assignment.

Another coverture look-alike which can lead to an inequitable result for the alternate payee includes the use of a real coverture-based formula, but then incorporates an additional ratio into the formula. In other words, the formula includes two ratios: one is the traditional coverture ratio of years earned during the marriage divided by years of service at retirement. But the sly attorney may sneak a second ratio into the equation which is based on the participant's average earnings as of the date of divorce divided by his average earnings at retirement. Don't be fooled by this approach if you represent the alternate payee. This second ratio will have the ultimate effect of "freezing" your client's share of the pension at divorce and she will receive none of the intended inflationary protection which is typically afforded under the traditional coverture approach. This double ratio coverture formula is tantamount to simply stating that the alternate payee is to receive 50% of the participant's frozen accrued benefit at divorce--and of course, you would never agree to this if you represent the alternate payee.