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Retirement Benefits And Closely Held Businesses/Stocks

The assumption is that retirement benefits acquired during the marriage are presumed to be marital property, regardless of whether the benefits are considered vested, matured, or contributory, per 5/503(b)(2). While the presumption can be rebutted, the grounds for rebuttal are few, such as rollover from a premarital interest, designation in a prenuptial agreement, or inheritance of a pension interest.

Allocation of retirement benefits can be tricky if the plan is not vested, however. Typically, the court will look at a “present value” calculation, in which the present value of the payments at the time of the divorce is multiplied by a fraction (determined by the years of the benefit accrual during the marriage prior to divorce, divided by the total years of benefit accrual prior to the divorce). If the present value cannot be determined, the application of this formula will typically be delayed until it is determined whether there will be a benefit payment.

On occasion, it may not be equitable to use a “straight” formula, as there may be variation between years as far as appreciation of the retirement fund/benefits. Per In Re: Walker, if the majority of the pension is non-marital, the whole of the pension is considered non-marital, but the marital estate is entitled to reimbursement. In other cases, it may be more equitable to use a year-by-year calculation (i.e. in situations where stock market fluctuations cause large increases or decreases in benefits during specific years).

Division of the benefits is slightly more complicated than other types of assets. The most common way of doing it is to use a Qualified Domestic Relations Order (QDRO) to directly allocate benefits and remove the non-participant from the plan. The value assignable to the non-participating spouse is transferred to him/her (either directly or into his/her own retirement plan) in a non-taxable transaction. This removes the non-participant from the plan in whole. A second alternative, typically used in cases where the employee spouse is almost retired, is the immediate offset. This is simply the participant spouse’s “buying out” the other spouse with other assets. However, this approach does not have the same tax-free benefit as a QDRO. Third, a QDRO allocation of the existing defined benefit may be used to keep both parties in the plan. The fourth alternative (which is a good option if underfunding puts the retirement plan in doubt) is the reserved jurisdiction approach. This is essentially a “pay as you receive” option, in which the participant makes payments to the non-participating spouse as he/she receives them, and the non-participant is no longer considered part of the plan. The court maintains enforcement jurisdiction (much as it would for enforcing maintenance payments).

The issue of retirement benefits should not be “reserved”, even if valuation or whether the plan will be paid, is not settled yet. Also, the spouses should be aware that any distributions from a plan are taxable to the participant, or the alternate payee, when the distribution is received. If an option such as the reserved jurisdiction approach is used, those payments can be made as maintenance to allow the paying party to apply an “alimony tax” deduction. This essentially shifts the tax burden to the payee.

A benefit plan which has a named beneficiary is subject to the named beneficiary’s rights as a priority (In Re: Smithberg). This is in line with the typical preference given to existing contracts in the context of inheritance or family law (notwithstanding allegations of fraud or dissipation). One must remember, however, that this priority will typically need to have its roots prior to any divorce settlement agreements, or even the divorce itself.

Finally, a few words about certain types of stocks, namely closely held businesses. The valuation of closely held businesses is considered tricky, as the nominal stock is often rarely traded or moved about (as it is often more about shielding individuals from liability). Revenue Ruling 59-60 is the statutory authority for determining the valuation of closely held businesses. The fair market value of a business is often changing, due to the economics of the time.

As a result, the major factors for determining the value of a closely held business include the nature and history of the business, the economic outlook of both the country and the applicable industry, the book value of the stock, the financial condition of the business, the business’ earning capacity, its dividend paying capacity, the existence of “goodwill” or other intangibles, the nature of the specific stock sales (such as the size of the stock to be sold), and the market price of similar business’ stock. Also to be considered is the presence of any restrictive agreements on stock sales (e.g. options). It should be noted, of course, that the general factors for property division as a whole apply. Whenever there is a closely held business to be valued, it is likely that expert testimony will be needed if there is going to be a dispute.

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