Application of the Coverture Fraction to a Deferred Distribution of a Tennessee Consolidated Retirement System (“TCRS”) Pension Plan
Robert Vance, CPA, ABV, CFF, CVA, CFP
Thank you to Robert Vance, CPA, ABV, CFF, CVA, CFP for allowing us to reprint his article describing and discussing this important appellate opinion and adding important notes.
ROBERT MARTIN THOMPSON v. CHRISTIE LEE THOMPSON, Appeal from the Circuit Court for Putnam County, No. 2015-CV-229 Amy V. Hollars, Judge, In the Court of Appeals of Tennessee at Nashville, No. M2020-01293-COA-R3-CV, Filed February 9, 2022.
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The sole issue on appeal in this divorce case pertained to the coverture percentage employed by the trial court to fund the husband’s marital interest in the wife’s retirement account via a deferred distribution method. The coverture percentage is the percentage of the coverture fraction awarded to the nonemployee spouse. Classically, the coverture percentage is 50% See, e.g., Croley, 2000 WL 1473854, at * 7 (holding that the “non-employee spouse should receive a portion, usually half, of the amount which is the [coverture] fraction multiplied times the employee spouse’s actual monthly retirement benefit”). But the coverture percentage can be any percentage that is agreed upon by the parties or deemed equitable by the court.
The coverture fraction also known as the “time rule formula” or “martial property interest” represents the marital portion of the benefits and is expressed:
Numerator: Years of Pension Service Accrued During Marriage
Divided By
Denominator: Total Years of Service at Retirement
During the majority of their marriage, both parties were employed as public educators, and each individually participated in and accumulated rights to defined benefit pensions through the Tennessee Consolidated Retirement System (“TCRS”). Wife began working as a teacher and participating in the TCRS in October 1995. Husband began working as a teacher and participating in the TCRS in 2000. Both Husband and Wife were still participating in their respective TCRS accounts when Husband filed for divorce in 2015 and when the final decree was entered.
Wife had accrued a considerably larger pension benefit payout due to her participation in TCRS for a longer period. Husband’s financial expert assigned a present value of $365,314 to Wife’s account and a present value of $115,013 to Husband’s; however, neither account vested during the divorce proceedings because the parties continued to work and participate in their respective TCRS account. See explanation at the end of this article on how to present value a TCRS pension.
When the case came on for a final hearing on March 19, 2018, the parties announced in open court that they had settled the division of the marital estate. Wife’s TCRS account was significantly larger than Husband’s account, and she lacked the liquid assets to fund a distribution of Husband’s marital interest in her TCRS account through offset at date of divorce. As a result, the parties agreed that Husband would receive a coverture percentage of 27% of Wife’s TCRS retirement benefits via a deferred distribution method.
The trial court’s Final Order was entered on October 29, 2018 stating:
Husband shall receive a share calculated by using a coverture percentage of twenty-seven percent (27%), and that the following formula shall be used to calculate Husband’s share of Wife’s retirement: twenty-two (22) years of marriage divided by Wife’s total years of TCRS service, said fraction being multiplied by twenty-seven percent (27%). The resulting percentage shall be applied to any payment from Wife’s TCRS retirement of any nature, including lump sum, monthly payments, beneficiary distributions or otherwise, and shall be paid directly to Husband by TCRS [emphasis added].
Wife filed a motion to alter or amend the trial court’s judgment or, in the alternative, for a new trial. Wife claimed that the Final Order:
erroneously set forth a division of [Wife’s] retirement benefits which would include the increase in value or growth of [Wife’s] retirement benefits after entry of the Judgment and through and until the date retirement benefits [are] distributed to [Wife].
Wife asserted that the Final Order erroneously permits Husband to receive more than his marital portion of her retirement benefits. She asked the trial court to amend the Final Order to reflect the “true agreement of the parties.” The trial court denied the motion and Wife appealed.
The bottom line of the matter is whether the implementing language the court employed to fund Husband’s marital interest in Wife’s retirement account via a deferred distribution method was contrary to the parties’ agreement as announced in open court or contrary to Tennessee law. The parties agreed to the application of the coverture formula with a coverture percentage of 27%. In response to a question by the trial court, Wife acknowledged that she understood and agreed to pay “a coverture percentage of 27% of the marital portion of the retirement to [Husband] upon her retirement” [emphasis added]. Husband made a similar acknowledgment.
Husband took the position that the standard coverture formula only applies to the marital share of unvested pension benefits because the coverture fraction requires the years of Wife’s service accrued during the marriage to be divided by Wife’s total years of service calculated on the date of her retirement. Husband further argued that application of the agreed-upon coverture percentage ensured an equitable division of the marital portion of Wife’s retirement benefits.
Wife contended the trial court’s order erroneously afforded Husband a greater division of Wife’s TCRS pension benefits. This argument is based on Wife’s contention that she agreed to Husband’s receipt of a specific percentage of the TCRS account accrued during their marriage, but that the trial court’s inclusion of the phrase divided by Wife’s total years of TCRS service in the coverture fraction affords Husband a greater distribution of her benefits than the parties agreed to and permits Husband to receive benefits based off an increase in value accumulated by post-divorce contributions. This is not necessarily true in that the longer the Wife stays in the TCRS plan, her monthly payout does increase; however, as the number of years or the denominator increases, the fraction decreases; therefore, Husband’s overall percentage decreases.
Tennessee authorizes two methods for the division of pensions in divorce proceedings: present value or deferred distribution. Present valuing a pension involves discounting the currently accrued monthly payout figure as if the spouse separated from service on that day using whatever formula the employer uses. In contrast, “deferred distribution” does not require a determination of the present value. Instead, “the court may determine the formula for dividing the monthly benefit at the time of the decree but delay the actual distribution until the benefits become payable” [emphasis added]. Thus, the deferred distribution method permits the nonemployee spouse to receive their marital share in the future rather than at the time of divorce. Deferred distribution is preferred when the marital estate does not contain sufficient assets to offset an award upon divorce of the parties which is the case with the Thompsons.
When vesting or maturation is uncertain or when the retirement benefit is the parties’ greatest or only economic asset, courts have preferred the “deferred distribution” method to distribute unvested retirement benefits [emphasis added]. Cohen, 937 S.W.2d at 831 (citing Kendrick, 902 S.W.2d at 927–28).
The trial court used the following to compute the formula: 22 years of marriage divided by Wife’s total years of TCRS service at retirement, said fraction to be multiplied 27%. The resulting percentage of that calculation was then ordered to be applied to Wife’s monthly TCRS retirement. The appellate court acknowledged the possible confusion presented by the trial court’s reference to Wife’s equitable interest of 27% as a “coverture percentage of 27%,” but they recognized that in application, the trial court correctly applied the deferred distribution method. In explaining the division of Wife’s retirement account, the trial court ordered the coverture fraction to be multiplied by 27%, which the parties agreed represented Husband’s equitable interest in the martial portion of Wife’s pension benefits. The trial court ordered that the resulting percentage “should be applied to any payment from Wife’s TCRS retirement.”
Despite the trial court’s references to a “coverture percentage of 27%,” the appellate court stated this it was apparent from the record that the trial court was referring to an equitable interest of 27%. The appellate court affirmed the judgment of the trial court in all respects.
Although this was not explained in the case, TCRS uses a formula to figure the Monthly TCRS Benefit as follows:
AFC or Average Final Compensation which is the average of the member’s five consecutive years of creditable service for which the member received the highest salaries,
Times
A factor of .01 if you are a Hybrid member (those hired after July 2014) or .015 for a Legacy member (those hired before July 2014),
Times
Years of Creditable Service,
Divided by
12
Times
Benefit Improvement Percentage of 1.05 (5%) as a Local Option Multiplier if applicable,
Equals
Monthly TCRS Benefit
The resulting Monthly TCRS Benefit is hypothetical in a divorce case since the member is not actually retiring at the date of divorce. The actual benefit upon retirement will most likely be higher as AFC and Years increase post-divorce. The hypothetical benefit is then discounted to present value twice. First for the Payout Period to account for the monthly payouts that would occur after date of retirement through a statistical life expectancy. Second, that present value figure of the payments is discounted to present day to account for the Deferral Period or the time from date of divorce until retirement date. The discount rate is usually based upon a U.S. Treasury Bond Rate. If the spouse has time accrued in the plan before marriage, than a Coverture Fraction should be applied to the present value to account for the separate property interest.
A TCRS value for divorce is not the Account Balance resulting from a member’s contributions from their paycheck and kept by TCRS accruing interest. TCRS is a defined benefit plan and the retirement benefits are based upon the formula. Retirement benefits are funded by employer contributions, employee contributions, if applicable, and investment earnings. The Account Balance is available to the member or beneficiary if the member dies or leaves service before vesting which requires completing five years of creditable service.
One factor that is a huge difference maker is accounting for the annual Cost of Living Adjustment (COLA) which most public pensions like TCRS have in place. I have compiled my own list of the TCRS COLAs going back to 1975 (this is a list you will probably not be able to find to this extent anywhere other than with me). The 2022 COLA was 5.9%, but the 5 year average is 2.58% and the 10 year average is 1.84%. After deciding what Treasury Bond rate to use, the COLA is subtracted from that rate to be used for the Payout Period discounting which decreases the discount rate which increases the present value. Failing to apply the COLA adjustment can undervalue the pension by tens of thousands of dollars.
Thank you, Rob.
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