If you have a nonqualified deferred compensation plan balance that is a substantial marital asset, you need to consider the pros and cons of various equitable distribution solutions. Basically, there are two ways to handle the distribution of these types of plans.
1) Both parties can receive their entitlement at the time payments are made, or
2) the non-titled party receives a present value in lieu of future entitlement.
To understand the consequences of each method, the following article offers a concise overview of what needs to be considered.
by Noah B. Rosenfarb, CPA, ABV, PFS, CDFA
When nonqualified deferred compensation plans ("NQDC") exist in a marital estate, they are often substantial components of the marital balance sheet. If your case includes a nonqualified deferred compensation plan, you and your client need to consider the pros and cons of various equitable distribution options.
Background - Plan Basics
NQDC plans vary widely; as the reason for their "nonqualified" status is that they do not meet certain ERISA guidelines. In the most basic sense, all plans have a few things in common:
There is two distinct paths to resolve the equitable distribution of nonqualified deferred compensation plan value:
- Both parties receive their entitlement at the time payments are made (i.e. "as, if, and when"); or
- The non-titled party receives a present value in lieu of a future entitlement (i.e. "buy out").
There are positive and negative consequences to examine under both scenarios before reaching an agreement with your adversary.
Referred to as "as, if, and when" language, most cases settle that the non-titled spouse receives their equitable portion when it is received by the titled spouse. In these scenarios, the greatest benefit is that the risks of the plan (discussed in detail below) are shared by both parties. The challenge most frequently discussed during litigation include the application of tax rates (marginal or effective; inclusion or exclusion of social security and other withholding taxes; and the means for calculating these amounts).
Another common issue when the titled spouse anticipates continued contributions into the nonqualified deferred compensation plan is the determination of the appropriate entitlement for the former spouse. In response to this concern, some plans have the ability to create a "slot" for the non-titled spouse. If their entitlement is fifty percent of the plan balance at the date of complaint (plus passive appreciation/depreciation), that amount is accounted for by the plan administrator as if it were another account. Often this accommodation includes the ability to have different investment options between the titled spouse's account and the non-titled spouse's "slot" account. If this option is available, there is no need to be concerned with the impact of future contributions.
However, not all plans offer this option. So, when the titled spouse will only have one account, the issues of calculating the non-titled spouse's entitlement in the future payout is complicated and generally requires the use of actuaries at the time distributions are made.
In a recent case, an opposing expert argued the non-titled spouse should receive a fraction of the future payment equal to their entitlement percentage (assume fifty percent) times the number of years the titled spouse was in the plan while married divided by the total number of years in the plan (i.e. a "coverture fraction"). Attorneys and clients must consider the impact of using this methodology. Can the titled spouse control the amount of the deferral, thereby allowing them to manipulate the future payment stream? Will future contributions result in an unfair distribution to the non-titled spouse?
Last, there is often the issue of selecting investment options. If only one investment selection can be made for the entire portfolio, it will generally be made by the titled spouse. The portfolio they select may not be in line with the non-titled spouses' risk tolerance or investment objectives. Consider the impact of investment selection and discuss these risks with your client. What if the titled spouse elects 100 percent investment in bonds and does not generate the anticipated growth of plan assets? Or invests 100 percent in emerging markets which decline substantial before payments begin?
Often desired by one or both parties, the buyout option includes a credit to the non-titled party equal to the present value of their future entitlement. The obvious difficulty is agreement on a present value calculation. To account for the present value in a nonqualified deferred compensation plan, you must consider the following factors, many of which are often overlooked:
In considering the factors listed above, a determination must be made of the discount to apply to the NQDC plan balance. In my opinion, beyond the current tax impact (item #1), it is generally reasonable to discount the plan balance an additional 10 to 15 percent to account for the remaining factors.
If you have a nonqualified deferred compensation plan balance that is a substantial marital asset, consider the benefits and detriments to various equitable distribution solutions. Common ground can often be reached once all of the variables are discussed between the parties and all of the risk factors are evaluated.
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