## Pennsylvania Law WeeklyMarch 13, 2000 Pension plans are usually either defined benefit or defined contribution plans. Two common examples of defined contribution plans are 401 (k) and thrift savings plans. It is well known that defined benefit plans need to be present valued. But since defined contribution plans have an account balance for an individual, many family attorneys and mediators believe that a defined contribution plan does not need valuation. This is not so. In fact, a defined contribution plan not only needs valuation, but failure to do so can greatly underestimate or overestimate the pension value. This can seriously impact on the client's equitable distribution. Although the valuation of a defined contribution pension is more straightforward than a defined benefit valuation, the computation still may be highly complex.
If the cutoff date is close to the valuation date and the pension is entirely marital, the family attorney or mediator need only use the current account balance and does not need to get the defined contribution pension valued. Suppose the cutoff date is several years before valuation and the date of entry is after the date of marriage. Then, the cutoff date account Mance is entirely marital. However, using the cutoff date account balance will greatly underestimate the marital present value of the pension, while using the current account balance will greatly overestimate the marital portion. The marital account balance must be brought forward with earnings until the date of valuation. If there have been contributions after the cutoff date, the earnings on the marital portion must be segregated from the earnings on contributions after the cutoff date. It turns out that performing this calculation accurately involves a considerable degree of computation. Essentially, the interest rate for every statement must be estimated. From this estimate, the marital and non-marital earnings can be directly calculated. The non-marital earnings plus non-marital contributions are then added to form the nonmarital portion, while the cutoff date balance plus earnings on that amount form the marital balance. The non-marital plus marital portions are added and compared to the total account as of a known statement date close to the valuation date. Because the interest rate was estimated, the two portions must then be balanced so that their sum equals the account balance as of the statement closing date, forming an exact solution.
A simplified example will illustrate the process. In this illustration, assume that the cutoff date is Dec. 31, 1995, and the valuation date is Dec. 31, 1998. - On Dec. 31, 1995, the balance was 100,000, the contribution was $3,000, the gain was $10,300, the interest rate was 1.1015, and the non-marital portion was $3,818.
- On Dec. 31, 1996, the balance was $113,300, the contribution was $3,000, the gain was $11,630, the interest rate was 1.1013, and the non-marital portion was $3,467.
- On Dec. 31, 1997, the balance was $127,930, the contribution was $3,000, the gain was $13,093, the interest rate was 1. 1012, and the non-marital portion was $3,148.
- On Dec. 31, 1998, the balance was $144,023.
Assume that the date of marriage is before hire so that the cutoff date balance is entirely marital. The annual interest rate is estimated based upon the annual gain. Note that an interest rate of 1.1015 is equivalent to 10.15 percent interest. This format is used for compounding interest. The aggregate compound interest rate over the three year period is 1.3358, calculated by multiplying the three interest rates. The marital portion as of Dec. 31, 1998, is 1 .3358 x $100,000 = $133,580. This is the investment gain on the cutoff date balance, plus the initial balance. The non-marital portion is the sum of three contributions, plus earnings on those contributions. The total is $10,433. The combined marital balance plus non-marital balance is $144,013. But we know that the actual total as of Dec. 31, 1998 is $144,023. Multiplying each portion by (144,023/144,013) brings the total to $144,023, balancing the result. Thus, the marital portion as of Dec. 31, 1998 is (144,023/144,013) x $133,580 = $133,589. Practically speaking, the balancing step is not needed in this case, but is shown for illustration. An approximate technique is adding up all the gains after the cutoff date, and calculating the marital portion using a ratio. However, this method can lead to large errors, and cannot be used at all if there are missing statements. If the hire date is before the marriage, the marital portion as of the cutoff date must be calculated. In Pennsylvania, this is done by subtracting out the balance as of the date of marriage, following the Paulone case. For example, suppose the entry date was in 1975, and the marriage was in 1980. Assume the account balance as of the date of marriage was $10,000. Then the marital portion as of the cutoff date, Dec. 31, 1995, is $100,000 minus 10,000, or $90,000. The marital portion as of Dec. 31, 1998 is $90,000 x 1.3358 = $120,222. Thus, $10,000 as of Dec. 31, 1995 is non-marital. This grows into $10,000x 1.3358 = $13,358 as of Dec. 31, 1998. In addition, the non-marital portion as of Dec. 31, 1998, includes $10,433, which is the post-separation contributions plus earnings on those contributions. The total non-marital portion as of Dec. 31, 1998, is $13,358 + $10,433 = $23,791. The total marital plus non-marital is $144,013, as before. A portion of the marital balance was shifted to the non-marital side, with the same total. After balancing, the marital portion becomes $120,230. Again, the balancing step is not really needed here, but is shown for illustration. Most states do not have case law on defined contribution plans, which follows the general pattern of neglecting the valuation of these plans. But defined contribution plans are a significant and growing portion of the pension picture, and accurately valuing a defined contribution plan is as important as valuing a defined benefit plan. Published with permission from Pennsylvania Law Weekly |