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QDRO Preparers drafting QDROs now must contend with a new type of retirement plan called a "cash balance pension plan," a hybrid that is not really the fish of a traditional defined benefit plan, nor the fowl of a defined contribution plan.
Neither fish nor fowl, a cash balance plan features elements common to both the defined benefit plan and the defined contribution plan. Though technically a defined benefit plan, its individual accounts, which permit lump-sum distributions upon termination, make the cash balance plan resemble a defined contribution plan.
When companies began converting tradition defined benefit plans to cash balance plans, older workers protested that the new routine discriminated against those who were near retirement. Moreover, what was termed a "whipsaw" resulted in the calculation of a participant’s account value when different rates -- one for compounding and one for discounting -- were applied.
In a cash balance plan, Joe the Worker at XYZ Corp. receives "defined" pension credits that are a predetermined percent of his annual salary, for example, 6 percent. In addition, Joe receives what a called "interest credits," which are based on the annual investment earnings, for example, 5 percent. But if in investing Joe’s account, XYZ’s cash balance plan receives a 12 percent return, for example, the 7 percent difference goes to the plan, not to Joe’s account. Unlike returns earned in a 401k, which can have real losses and gains in the market, the interest credits, like the pension credits, of a cash balance plan are preordained and set, and Joe has no say in investments in his account.
Many large older established companies began converting tradtional defined benefit plans to cash balance plans several years ago when they began to buckle under the weight of what were termed "legacy costs" that made the traditional company pension plans so expensive to operate. Under the old regime, a worker’s pension is based on his or her final average earnings, when he or she is at his peak earning, and on his total years of service. Thus, a worker who retires at 65 with 40 years of service receives a pension based on his average salary times his 40 years of service. By comparison, under a cash balance plan, the worker receives an annual pension credit for each year’s actual salary. For example, if Joe the Worker is covered by a traditional defined benefit pension plan, his accrued pension benefit is not based on a percentage of his early years when his wages are low, but based on his annual compensation later in his career when his wages are much higher.
QDRO Preparers dividing pensions must understand the difference between the traditional defined benefit plan and the cash balance plan because the type of QDRO that is appropriate will be different (as may be the entire marital property division strategy).
Most attorneys representing Joe the Worker, the participant, lean toward a deferred distribution of the cash balance plan; those representing Joe’s wife, the nonparticipant, push for a cashing out with other offsetting assets.
The difficulties in dividing a cash balance pension plan may be complicated so more by the fact that many, if not most, of these plans started as traditional defined benefit pension plans. This means that the plan was converted to a cash balance regime and that, as part of the conversion, the accrued monthly benefit -- the amount that would be payable to Joe the Worker on a monthly basis for the rest of his life beginning when he reaches age 65 -- must be calculated. However, since the cash balance plans (like the 401(k)), contain the individual accounts of all the Joe the Workers covered by the plan rather than the accrued monthly benefit amounts, XYZ Corp. must convert Joe’s monthly payment to a lump sum amount. The lump sum amount of conversions has been contested in at least three federal court cases, because litigants have contended that "the participant’s stated account balance was not judged to be the actual value of the plan." Hence, the "hypothetical" quality of the account in a cash balance plan.
To deal with this, a QDRO Preparer must determine when the company established the cash balance plan and whether it was converted from a traditional defined benefit plan. Then, he or she can draft a QDRO using one of four basic models. They are as follows:
1. Percent of Total Account Balance as of the Date of Divorce: Provides the alternate payee with a specified percent of the total account balance at the time of the divorce. Ideal for a party who was not married when he enrolled under a traditional defined benefit plan.
2. Coverture Before Conversion and Percent of Account Balance after Conversion: Works if Joe the Worker was covered under a defined benefit plan before it was converted and married before the conversion.
3. "Frozen" Coverture as of the Date of Divorce: Applies a coverture-based formula to the participant’s total account as the date of divorce.
4. "Full" Coverture as of Date of Retirement: Works if Joe the Worker was close to his retirement when his plan was converted to a cash balance and a majority of his benefits will be earned under the traditional defined benefit plan.
Authored By: Theodore K. Long, Jr., President, Pension Appraisers Online, Inc.
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