5 of 5 DOCUMENTS 

Copyright (c) 1996 by the Florida Bar
The Florida Bar Journal 

May, 1996 

70 Fla. Bar J. 62 

COLUMN: THE NOT-SO-SIMPLE COVERTURE FRACTION: DO ATTORNEYS RISK MORE THAN EMBITTERED CLIENTS? 

By Jerry Reiss and Douglas H. Reynolds 

Jerry Reiss is an associate of the Society of Actuaries based in Palm Harbor. As an enrolled actuary, he has extensive experience with retirement plans. Among several other articles on the topic, he co-authored "Drafting QDRO's: A Malpractice Waiting to Happen," in the February and March 1995 issues of the Bar Journal, and "The Pension Trap: Trading Rights in a Divorce Settlement, in the June 1995 issue of the Illinois Bar Journal.
Douglas H. Reynolds is a Florida board-certified marital and family law attorney with the law firm of Cox & Reynolds in Ft. Lauderdale and practices in the areas of civil litigation and family law.
This column is submitted on behalf of the Family Law Section, Renee Goldenberg, chair, and William D. Palmer, Edna Y. Elliott, and Jane L. Estreicher, editors.  

TEXT: 
 [*62]  Part 1
Most family law attorneys who have confronted retirement plan issues more than once have, at one time or another, almost certainly worked with a coverture fraction. A coverture fraction is also called a time rule portion. n1 It equals the number of years or months of retirement plan participation during which both husband and wife were married, divided by the number of years or months that the participant participated in the subject plan. n2 This service fraction is then multiplied by some pension benefit in order to determine a marital portion of that benefit. This concept is so simple that many people who know little, if anything, about plans, feel comfortable using it. Unfortunately, this is often a very false comfort.

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n1 See Murray Projector, F.S.A., SYNOD OF DISSOLUTION ACTUARIES, 81-5 (Los Angeles County Bar Association, Family Law Section 1981).
n2 See Trant v. Trant, 545 So. 2d 429 (Fla. 2d D.C.A. 1989).

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It is a common perception that a coverture fraction has a dual application for defined benefit property. Applied to a benefit in pay status, it increases the marital benefit with COLA increases in salary occurring after the date of the dissolution of marriage. It is then reasoned, if it is applied to a current accrued benefit, that the product is a true representation (or at least a good approximation) of the earned marital benefit without such increases. Both perceptions are false.
There is a proper use for a coverture fraction, and an improper use. Part 1 of this article will concentrate on the proper use. An historical perspective of the coverture fraction will show that there was not only an intended proper use, but also that when used properly, it coordinates with the way benefit accruals are typically calculated by most plan administrators under ERISA. Government plans, like the Federal Employees Retirement System (FERS), and the Civil Service Retirement System (CSRS), provide model language, if used, of the proper use of a coverture fraction. Yet, federal rules are sufficiently flexible that a practitioner need not use the suggested language and may, accordingly, apply the coverture fraction improperly.
Proper use of a coverture fraction can be found in a QDRO where it is applied to some future (defined) benefit accrual occurring after the parties divorce. Even when applied properly, there are six scenarios that can often produce results different than expected. Two of them result in a windfall for the nonparticipant spouse. The other four can severely shortchange the nonparticipant spouse. In addition, proper use of a coverture fraction in a QDRO is often accompanied by unnecessary restrictions of many of the nonparticipant spouse's rights, simply because the drafter did not know how to deal with both the complexity of those rights and the coverture fraction at the same time. Failure to address these contingencies with protective language in the QDRO could pose serious malpractice liability for the practitioner.
Part 2 of this article will show the improper use of a coverture fraction suggested by the Trant decision. n3 The article will further demonstrate why it is error to follow Trant, and how it produces incorrect, unintended, and even nonsensical results which violate the Florida statutory definition of marital and nonmarital property.

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n3 Id.

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The Coverture Fraction and Its Roots
The concept behind a service fraction can be traced to the early days of ERISA, which could be used to satisfy certain minimum accrued benefit standards first introduced under ERISA. n4 This standard was known as the Fractional Method. n5

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n4 See ERISA 204(b)(1)(A), (B), and (C).
n5 See ERISA 204(b)(1)(C).

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A service fraction is created by taking the number of years of service (measured as plan years of service or total years of employer service) divided by the number of years of possible service at the normal retirement date defined under the plan. The fraction then produced is multiplied by a benefit at the normal retirement date in order to determine what portion of that benefit had been earned if the participant was then to separate from service. n6 The projected benefit at normal retirement, against which the fraction is multiplied, is a benefit that uses current average monthly compensation in the benefit formula, as if the participant's benefit was determined on the date of retirement  [*63]  using today's current average salary. n7

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n6 Id.
n7 It can be proven mathematically under the Fractional Method that an all marital accrued benefit determined at age x ("AB[x]") can be exactly converted into a marital accrued benefit using average salary y years later ("AB[x + y]") by multiplying the future accrued benefit at age x + y by coverture fraction which properly reflects the service components at age x + y. The proof breaks down when there is premarital service.

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The Fractional Method is the most widely used standard for determining benefit accruals under ERISA. Its use may be understood by the following two examples.
* Example 1: A benefit formula under the plan provides the participant with 50 percent of average monthly compensation. The accrued benefit uses the Fractional Method approach based upon plan years of participation. For purposes of our example, the participant-husband entered the plan at age 25 and will be eligible for normal retirement at age 65. He is now age 35 with an average salary of $ 2,000 per month.
His projected benefit at normal retirement age may be measured at any attained age. At age 35, this projected benefit is $ 1,000 per month: 50% x $ 2,000 per month. If he works from his date of plan entry, age 25, to his normal retirement age, 65, he will have then accumulated 40 years of service. At age 35, he has accumulated 10 years of credited service, from which it takes 40 years of service in order to accrue the full projected benefit. At age 35, that projected benefit is $ 1,000 per month. His accrued benefit measured at age 35 is 10/40 x $ 1,000 per month, or $ 250 per month.
If the participant married at age 35, his premarital portion of benefit would be the $ 250 per month calculated above, and first payable 30 years later at age 65.
* Example 2: Assume the same facts as in Example 1, except that the participant was married at age 35, and is now age 45, with an average salary of $ 4,000 per month.
His projected benefit at normal retirement age is 50% x $ 4,000/mo. = $ 2,000/mo. At normal retirement age, he still has 40 years of service. At age 45, he has 20 years of credited plan participation. The accrued benefit at age 45 is $ 1,000/mo.: 20/40 x $ 2,000/mo, as calculated in Example 1.
Florida law provides that property which is premarital n8 continues to be premarital unless there was a significant marital contribution that added to its appreciated value. n9 In this regard, an estate that was premarital would continue to be entirely premarital, unless the owner of that estate invested significant marital time trying to improve its value. It is clear from this law that an IRA asset acquired before the marriage, or a pension account balance accrued before the marriage, would be premarital. This premarital asset would be entitled to passive appreciation. n10 Any marital contribution that helps appreciate the premarital benefit becomes marital.

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n8 This article divides nonmarital property into premarital and postmarital portions. This distinction is necessary because the coverture fraction works differently on marital portions when there is premarital property.
n9 See FLA. STAT. §  61.075(5)(a)(2).
n10 See FLA. STAT. §  61.075(5)(b)(3) limited by FLA. STAT. §  61.075(5)(a)(2).

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In a defined contribution plan, this concept is easy to apply. Marital contributions, and the appreciation on those marital contributions, become marital property. It follows that everything else would be premarital. Everything else would include the value of the premarital property determined on the date of marriage, improved for passive earnings. In this regard, passive earnings mean earnings that do not require marital efforts.
States that divide property upon equitable distribution principles have complicated laws dealing with property issues. The issues become significantly more complicated when issues of defined benefit retirement property are raised, as a direct result of the fact that defined benefit plans are for the most part, misunderstood. The defined contribution plan has a simple-to-explain benefit. By contrast, the defined benefit plan provides many different benefits, and measurement of those benefits is very difficult because proper measurement requires zeroing in on a moving target. n11

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n11 In Example 1, the projected benefit which will be fully earned after 30 more years of participation was $ 1,000 per month. In Example 2, which was based upon the same facts as in Example 1, except projected 10 years later, the participant must now work 20 more years in order to earn fully $ 2,000 per month. As a moving target, the defined benefit plan defines current benefits based upon future events that constantly change with time.

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The defined benefit property has value on the date the parties marry, and the value of this benefit automatically improves with interest. This built-in interest rate automatically satisfies the requirement that the premarital benefit be increased with passive earnings. The problem that arises under a defined benefit plan is that what value the benefit has as of a particular date varies according to how the benefit accrual is viewed. n12 The only definition of a benefit accrual that is concrete is the ERISA definition that provides what would be paid if the participant separated from service on the date it was valued. This definition, however, has been uniformly rejected by family law decisions. n13 Then there is an equity problem with the defined benefit plan that simply does not exist with other plans. Most benefit value is disproportionately earned: Very little in the early years and much more in the later years. This fact presents family law courts with problems that don't exist with other plans. The value of benefits earned under a second marriage of much shorter duration often exceeds the value of benefits earned under the much longer first marriage, not necessarily related to any postmarital effort issue. Rather, this occurs simply because of the way that the defined benefit plan works.

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n12 See Reiss, The Emerging Marital Controversy: When Should Postdissolution Retirement Benefits Be Treated As Marital Property?, 7 DIVORCE LITIGATION 8, at 166, (National Legal Research Group, Inc., August 1995).
n13 See Diffenderfer v. Diffenderfer, 491 So. 2d 265, at 267 (Fla. 1986), quoting Majauskas v. Majauskas, 61 N.Y.2d 481, 474 N.Y.S.2d 699, 704-705, 463 N.E.2d 15, 20-21 (1984).

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Errors Resulting From Proper Use
* Intended Use of a Coverture Fraction
The coverture fraction was initially developed to be used with respect to a benefit-in-pay status. This use will generally protect a benefit, once earned, from inflationary costs. However, caution must be observed.
There are many serious coverture fraction errors occurring regularly when coverture fractions appear in QDRO's and other domestic relations orders. These errors occur for the same reason: The appeal of the coverture fraction is so great because of its simplicity. Unfortunately, applied to pension plans, it requires a much greater understanding of those plans, and the effect of its application to those plans, lest it produce great errors.
A coverture fraction applied to a benefit-in-pay status could result in the following errors:
* Errors That Overstate the Marital Benefit
A coverture fraction applied to a benefit-in-pay status could result in a windfall for the nonparticipant spouse going far beyond what might be considered marital property. This result can occur in two ways:
1) It can result from a plan amendment greatly increasing future accruals occurring after the date the parties divorced. n14

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n14 Retirement plans provide deferred compensation for services already performed. A plan amendment can change that rate of deferred pay for employee services on the date it is adopted. If that occurs after the divorce and is only applied prospectively, it represents a future pay increase for services not yet performed. This creates no marital property. See supra note 12.

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2) It can also result from a coverture fraction applied to a Civil Service benefit that was supposed to exclude a Social Security benefit equivalent to what the participant would have received had he participated in the Social Security program. n15 Use of a coverture fraction, together with the suggested language of the Office of Personnel Management, n16 will prorate that Social Security offset between marital and nonmarital portions, even though the Social Security benefit that replaces it would have been fully earned after 10 years.

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n15 In Hisquierdo v. Hisquierdo, 439 U.S. 572, 99 S. Ct. 802, 59 L. Ed. 2d 1 (1979), the Court likened tier one federal railroad retirement benefits with Social Security benefits. The Court further noted that recent Social Security law changes that permitted its assignment for purposes of alimony or child support specifically prevented it from being paid as property settlement under a divorce. The high court reasoned that as replacement to Social Security benefits, tier one benefits were entitled to be excluded from marital property in the same way that Congress had intended that Social Security benefits be excluded as marital property. Also see Bain v. Bain, 553 So. 2d 1389 (Fla. 5th D.C.A. 1990). The standard often used to determine the equivalent Social Security offset can be found under Cornbleth v. Cornbleth, 508 A.2d 369 (Pa. 1990).
n16 The Office of Personnel Management acts in the capacity of plan administrator for both the CSRS and FERS.

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 [*64]  * Errors That Understate the Marital Benefit
A coverture fraction applied to a benefit-in-pay status could decrease the benefit, even though it is based upon increases in salary, in the following circumstances:
1) A plan amendment that decreases the future benefit after the date of divorce.
Even when the salary increases, this increased salary is applied to a decrease in the rate of future accrual, which is shared with the marital portion when a coverture fraction is applied to a benefit-in-pay status. This result can be prevented by providing in the QDRO that the coverture fraction be applied to the benefit formula that was used to determine projected benefits during the marriage. This protective language will allow the marital portion to increase after the amendment to reduce future accruals, by factoring in further increases in average salary.
2) A plan amendment that freezes benefits before or after the divorce. n17

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n17 If the plan freezes benefits, the participant accrues nothing further. Yet the participant continues to participate in the plan, resulting in a decreasing service fraction. A constant benefit multiplied by a decreasing service fraction can result in a substantially decreased benefit payout.

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If the plan amendment is before the divorce, the coverture fraction should never be used. If it is after the divorce, the coverture fraction should be applied to the accrued benefit determined on the date that the amendment is adopted. This approach will ensure that the marital benefit never decreases, and will increase up to the date that the plan freezes benefits.
3) A benefit formula that is based upon final high average salary.
There is always the possibility that the average salary component could decrease. When applicable, there should be protective language that prevents the benefit from decreasing over what would have been paid had no coverture fraction been applied in the first place. This protective language should only be used when the benefit formula is based upon final high average salary. n18

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n18 This is not error under the Marital Foundation Theory.

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4) A participant with substantial premarital service, and a nonparticipant spouse who applies for benefits soon after the divorce.
Use of a coverture fraction in this setting assumes that the participant has terminated employment, which has not occurred.
When a coverture fraction is applied to a benefit-in-pay status, and there is premarital service, all portions of benefit earned during identical periods of duration will result in identical benefit amounts. This results in an enhancement for some marital benefits that will not be paid for many years, but discounts the marital portion ending with or near the date it is received by the nonparticipant spouse. If the participant has not yet terminated employment, the discount is unjustified because the participant can continue to greatly increase the benefit in a period during which the maximum benefit increases are generally seen. This result is a major shortcoming of the coverture fraction (and is not understood by the reported decisions). With this in mind, the drafter must carefully consider whether it makes sense to use a coverture fraction when there is a substantial premarital plan participation. In many instances, the answer appears to be no, even though most drafters may have never considered the point.
* Unnecessary Restriction of Benefit
Use of a coverture fraction in a QDRO often needlessly restricts the rights of the nonparticipant spouse to receive the benefit at the same time that the participant retires. This unnecessary result occurs when this approach is used because the drafter understands that one cannot apply a coverture fraction to a benefit-in-pay status if the participant has not yet begun to receive benefits. A simple modification to how that coverture fraction is applied can accommodate this situation.
When the coverture fraction is applied to some distant future benefit, survivorship rights are more often over-looked, and the benefits are seldom structured to take advantage of early retirement subsidies. n19

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n19 See Cardoza, Divorce Lawyers Are Making Big Mistakes With Pensions, 95 LAWYERS WEEKLY USA 23 (Nov. 6, 1995).

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The Marital Foundation Theory
Many community property states subscribe to the Marital Foundation Theory. A state need not be a community property state in order to support this theory. n20 Under the Marital Foundation Theory, the coverture fraction problem simplifies into proper use mostly without unintended errors, and improper use (under Trant) replete with unintended errors.

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n20 In Hunt v. Hunt, 909 P.2d 525 (Colo. 1995), the Colorado Supreme Court withdrew its opinion and granted a motion for rehearing. On December 18, 1995, the court reversed a prior ruling and embraced the Marital Foundation Theory.

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Many courts, including Florida courts, have been greatly confused by the marital and nonmarital efforts issue in connection with dividing marital defined benefit plan property. Defined benefit plans determine retirement benefits based upon some future plan provisions and future earned salary. Defined benefit accruals are based upon current salary and are used to establish minimum benefits that cannot be forfeited. Both results have led many courts to conclude that the property earnings under a defined benefit plan are directly related to the effort that was expended during the time that the benefit was earned. This conclusion is simply not true and courts are slowly beginning to deal with this inaccuracy.
A retirement plan that provides an employee with certain benefit rights serves as a contract between the employee and the employer, and provides that employee with deferred wages for work that was previously performed. n21 These benefits accumulate with service, as do the components that were used to determine the amount of benefits. Components include the benefit formula (which can change) and method of accrual, as well as the salary that is ultimately earned.

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n21 See Brown v. Brown, 15 Cal.3d 838, 544 P.2d 561 (1976). Also see Majauskas v. Majauskas, 61 N.Y.2d 481, 463 N.E.2d 15, 20-21 (1984), and ERISA §  2(c).

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What salary a participant earns is often directly related to the amount of prior service that was invested in achieving education and skills that supported that rate of pay. n22 When there are extra steps taken in order to improve one's skills, these extra steps do not occur in a vacuum, and are often related to what occurred before. n23 Promotions are almost always based upon a combination of prior experience and improved skills. This fact makes it virtually impossible to distinguish between the amount of marital and nonmarital efforts that may have figured into a promotion.

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n22 In re Marriage of Bullicek, 59 Wash. App. 630, 800 P.2d 394 (1990).
n23 See Gemma v. Gemma, 105 Nev. 458, 778 P.2d 429 (1989).

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 [*65]  The level of benefit that may be provided either by the amount of benefit formula, or the method of accrual, is directly related to the amount of current earned salary. Management is mindful of its costs for providing employee benefits and adjusts its costs (based upon salary at retirement) in combination with current salary, in order to present the employee with a total salary package. n24

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n24 An actuary must determine the current pension costs on the basis of future salary. See Treas. Reg. §  1.412(c)(3)-1(c)(4)(i). These current pension costs effect what would otherwise be paid to an employee as current salary. See Majaukas v. Majauskas, 61 N.Y.2d 481, 463 N.E.2d 15, 20-21 (1984).

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It is clear from the preceding that compensation, including benefits, is based upon a foundation of efforts, beginning first with the earliest days of employment. The earned benefit, as it relates to marital efforts, can then only be determined after the entire benefit structure has been built, and this is only known at retirement.
Part 2 of this article, which will appear in the June issue of The Florida Bar Journal, will examine how Florida courts have addressed the use of a coverture fraction in the Trant decision.