SHOW ME THE MONEY: TRACING PRE-MARITAL RETIREMENT ACCOUNTS IN KENTUCKY AND OHIO

Smith v. Smith, NO. 2011-CA-002306-MR (Ky. App. 2014)
Evidentiary Burden is on Employee to Prove Non-Marital Amounts to be Assigned as Separate Property Interest

Rendered: May 23, 2014
To Be Published
Opinion Affirming

This blog post analyzes the evidentiary burden of proving a non-marital separate property interest in a commingled defined contribution retirement account under state domestic relations law in both Kentucky and Ohio.  First, the holding in Smith is examined; then this post provides family law practitioners on both sides of the river with applicable law specific to each jurisdiction, as well as some practical guidance. 

***     ***     ***

There’s nothing new to see here, folks.  But since the matter has been visited recently by the Kentucky Supreme Court in Ford v Perkins, No. 2011-SC-000330-DG (Ky. S.Ct., Oct. 25, 2012), and now twice by the Kentucky Court of Appeals in the past six months, it sure seems worth taking another look.  See Fitzgerald v. Fitzgerald, No. 2012-CA-000532-MR (Ky. App. 2013), and my blog post dated November 21, 2013; see also Smith v. Smith, No. 2011-CA-002306-MR (Ky. App. 2014). 

In Smith, Wife claimed a separate property interest in an IRA account opened after the marriage, but purportedly with her own pre-marital funds; her claim included the opening account deposit and included the passive market appreciation thereon.  The Court, in affirming the trial court’s denial of Wife’s claim, bluntly capsulized the rule when it comes to claiming a separate pre-marital property interest that has been commingled in marriage.  That is, the evidentiary burden is on the party claiming the separate property interest to prove the non-marital amount.  Period.  The Smith Court opined (at page 15):

[Wife does not] address whether any increase in value was based on the parties’ joint efforts. Indisputably, any contributions and interest earned after the marriage are marital.  Thus, [Wife] did not meet her evidentiary burden to prove the amount of the nonmarital portion or to trace it to the Fidelity IRA. 

Whenever there is a 401(k)-type plan with a pre-marital account balance, any post-marital contributions and passive market appreciation thereon are marital, which the Smith Court aptly recognized.  However, the marital portion is integrally commingled with the employee-spouse’s pre-marital contributions to the account, and any passive appreciation on those prior contributions that has accrued during the marriage.  So how does the employee-spouse meet the evidentiary burden of proving that pre-martial contributions and passive growth thereon are separate property to be excluded from equitable division?  That's the crux of the matter.  And the purpose of this blog post. 

What is Passive Appreciation?

Courts make a distinction between "active" and "passive" appreciation within the context of divorce.  Passive appreciation – as the term is used in this blog post – describes the market growth experienced on the account balance of a 401(k)-type plan during the period of marriage.  This appreciation is termed as "passive" due to the fact that the growth in the account is not a direct result of the efforts of the parties during the marriage, but rather the effect of market fluctuations and positive investment experience. 

How Does State Domestic Relations Law View Passive Appreciation?

Determining the amount of the account balance available from a 401(k)-type plan for equitable distribution in divorce can be complicated when a balance already exists at the time of the marriage.  Most states have statutory or code sections like Kentucky and Ohio that treat any increase in value of property acquired before the marriage as the non-marital separate property of the employee-spouse to the extent that any increase does not result from the joint efforts of the parties during the marriage. See ORC § 3105.17.1(A)(6)(a)(iii); KRS §403.190(2)(e). 

However, most state courts also interpret controlling law as creating a presumption that any said increase in value during the marriage is marital property.  Therefore, a party asserting that he or she should receive such appreciation upon a pre-marital contribution as his or her separate property carries the evidentiary burden of proving the portion of the increase in value attributable to the pre-marital contribution.  By virtue of the presumption, the failure to do so will result in any increase being characterized as marital property.  See Smith at page 7; see also Travis v. Travis, 59 S.W.3d 904 (Ky. 2001); Goff v. Goff, 2010 WL 3810735 (Ky. App. 2010); Burkholder v. Burkholder, 1994 WL 90385 (Ohio App. 9 Dist. Wayne County 1994); Cooper v. Cooper, 2008 WL 4278215 (Ohio App. 2 Dist. Green County 2008). 

How Does One Determine the Value of Passive Appreciation in Kentucky and Ohio?

In jurisdictions such as Kentucky and Ohio, tracing is utilized as an evidentiary vehicle to value and prove the passive increase of pre-marital contributions in a 401(k)-type plan during the period of marriage.  Tracing allows one to make an accurate determination of the growth (or loss) on both the marital and non-marital contributions in the account by calculating the rate of return experienced on the account during the marriage.  There are several methods of tracing the passive growth of pre-marital account balances for 401(k)-type plans, though depending on the historical account records available, accuracy will vary.  

For instance, if the marriage was long-term, the plan may not have records dating back to the date of marriage.  It is further possible that the plan may have switched recordkeepers once or multiple times during the marriage, and records from the previous recordkeeper are no longer accessible.  However, when adequate records exist, the results of tracing for the employee-spouse can be profound.

Take the following example from one of my own cases, wherein I traced the passive growth of a pre-marital account balance over the span of a ten-year marriage:

The balance in Steven’s 401(k) on his date of marriage was $173,364.  At the time of the divorce, the account had grown by $251,266 to $424,630.  However, of this $251,266 increase, it was determined that only $144,290 was divisible due to contributions made during the marriage, and passive market growth thereon.  Therefore, Steven retained $280,339, in addition to half of the divisible $144,290. 

Without any account records, or other competent evidence, a court may have instead found the full $424,630 divisible – netting $212,315 to each spouse.  However, because Steven maintained good records, he ended up with $352,485, and his spouse with $72,145.  See?  Rewarding results, indeed.

What is the Preferred Method of Determining Passive Appreciation?

Tracing pre-marital passive market growth can be an arduous task, but it doesn’t take rocket scientist to see its worth.  When tracing is not possible due to lack of plan records, the court cases cited above show the value of having ‘something else’ at trial to meet the burden.  The same is true in negotiating an agreement between the parties.  In fact, when consistent account records spanning the marriage are not available, there are many ‘tracing alternatives’ to otherwise establish (or settle on) at least some portion of the pre-marital account balance, and in most cases, even ascertain a portion of any associated passive growth.  All have varying degrees of accuracy, of course. 

Depending on the circumstances of each case, your expert can help you determine if adequate records exist to accurately trace the pre-marital growth in a 401(k)-type plan (generally at least annual statements are necessary), or otherwise determine the best available alternative evidentiary method to establish the value of any non-marital property interest.  Some options include:

  • Using an agreed upon rate of return, perhaps based on an average annual return of aggregate bond index over the period of marriage
     
  • Compounding the pre-marital balance by investment returns over the period of marriage (that is, when the account balance as of the date of marriage is determinable via account records or interpolated by wage history)
     
  • Using software to track the rate of return of certain agreed upon mutual funds over the period of marriage, particularly when at least sporadic account records are available
     
  • Appealing to the plan to provide yearly rates of return for various non-mutual fund investments in addition to a detailed record of the money movement
     
  • Using a time-based coverture method (when all else fails)
     
  • Using the lesser desirable ‘subtraction method’, which will at least secure the account balance at the time of marriage (if a beginning pre-marital balance can be determined)

A final note of caution, your expert should be knowledgeable in state domestic relations law as it applies to the division of retirement assets.  State courts have shown a tendency toward 'actual information' versus guesstimates.  Therefore, one must take heed when considering an alternative means of estimating the non-marital property interest in lieu of tracing.  For instance, in Kentucky, Courts rely heavily upon the “Chenault Rule”, which requires a party seeking to trace non-marital property into a present marital asset to show that “he or she has spent his or her nonmarital assets in a traceable manner  during the marriage” (emphasis added; the Smith Court succinctly explains the “Chenault Rule” at pages 5-6 of the Opinion).  In Ohio, the Code itself expressly mandates at ORC §3105.71(A)(6)(b):

The commingling of separate property with other property of any type does not destroy the identity of the separate property as separate property, except when the separate property is not traceable.  

(Emphasis added).

For this reason, under Kentucky and Ohio domestic relations law, tracing is the preferred method to determine the martial and non-marital portions of a 401(k)-type plan.  When tracing doesn’t appear to be a viable option, the family law practitioner should be prepared to get creative and aggressive, and perhaps should even consider issuing subpoenas to employers or plan administrators. 

The amounts at stake can be significant.  Therefore, when your client tells you that there is a pre-marital component to his or her defined contribution retirement account - a thorough exploration of all the possible options available to establish a separate property interest is a must.