Pension sharing upon divorce

Annabel Andreou explains the different ways in which pensions may be treated in the context of divorce

Over a person’s working life, they will make National Insurance contributions which will later provide them with their state pension and additionally contribute to private pensions which are often set up by employers (workplace pensions) or by the individual.

There are various types of private pensions, but pensions will commonly fall into one of two categories: defined contribution schemes and defined benefit schemes.

1.      Defined contribution schemes are valued based on the contributions which have been made to the pension pot and how the pot has grown over time. Various factors will influence how much a member will get upon retirement, but the amount is not set in advance and will be subject to contributions, tax allowances, charges and investment performances.

2.      Defined benefit schemes are valued by what benefits are provided for and given to a member when they retire. All public sector and uniform pensions are defined benefit schemes. How much a member will get is set in advance. The benefit of this is a member’s retirement income is guaranteed. Various factors will have an impact on the money which is actually paid out, such as: length of service, the member’s salary and the accrual rate.  

Members should understand the nature of their pension scheme, what benefits are provided and how the pension is valued. This will enable members to financially plan for their retirement with regard to any particular life events such as divorce and/or remarriage.

Pensions on divorce

When a couple are divorcing, their finances will need to be considered to ensure a fair outcome. Various factors will be considered to determine what is fair and the court will consider the factors set out at section 25 of the Matrimonial Causes Act 1973.

The court will be mindful that not all assets are valued in the same way and that it is inappropriate to account for certain assets at ‘face value’. For example, a pension’s valuation is intrinsically different from that of a house and there is a risk a pension may be undervalued or overvalued if not properly considered. The consequence of this is an incorrect figure could be used which will distort the overall value of the matrimonial pot and may result in an unfair outcome.

Lawyers will regularly advise clients to instruct a Pension on Divorce Expert (PoDE) to advise on the value of the pension and how the pension can be dealt with.

There are three ways in which a court can deal with pensions:

1.      Pension sharing order;

2.      Offsetting;

3.      Pension attachment order/earmarking.

Pension sharing order

This is the most common way in which pensions are dealt with. A pension sharing order will give instructions to the pension scheme administrators. These instructions will set out what percentage of the member’s pension value will be transferred to the receiving party.

The pension can be shared as follows:

1.      The receiving party can become a member of the pension scheme and have their share of the pension transferred into their own account;

2.      The receiving party can have their share of the pension transferred to a different pension scheme which they are already a member of or have set up.

The receiving party should seek independent financial advice about their options.

A pension sharing order will provide both parties with an income upon retirement – notably there is no requirement for the parties to retire at the same time and this can be of particular importance when there is a significant age difference. 

Offsetting

This is the process whereby a right to a certain asset is traded off against another asset. One of the most common approaches is for one party to offset their right to receive a pensionable income later against retaining a greater share of the family home now.

Offsetting can give rise to various difficulties such as:

1.      Incorrect valuations – the parties run the risk of pensions being over/undervalued. The consequence of this is the settlement will not accurately reflect the value of the matrimonial pot which can result in unfair outcomes;

2.      Differing tax consequences – if one party retains their pension, they will pay income tax on the retirement income they receive. The party who retains and lives in the family home will usually have no tax liability as and when they decide to sell it;

3.      There is the risk the party who retains their pension will not have enough capital to rehouse themselves and the party who retains the family home will not have a pension which provides them with enough income upon their retirement to meet their needs.

Every case will need to be considered on its own merits and the needs of the family will have to be carefully considered. Important factors include the parties’ ages, their earning capacity, whether either party has a disability and the parties’ recourse to other sources of income and capital.

Earmarking

Earmarking is the process whereby a percentage of a member’s pension is paid to their ex-spouse at regular intervals.

Under a pension attachment order, payments are made directly from the member’s scheme straight to their ex-spouse’s nominated bank account. A consequence of this is the receiving party will need to wait until the member starts to draw-down on their pension before they can receive their share.

This can give rise to issues where there is a significant age gap, or the member party decides to not draw down on their pension if they are still working or have access to other sources of income. Furthermore, the pension payments to the ex-spouse will automatically end on the member dying which can leave the receiving ex-spouse without an income. Pension payments to the ex-spouse will also cease if they remarry.

Pension attachment orders are very uncommon due to their limitations.

Advice & experts

A separating couples’ pension provision must always be considered.

The cash equivalent transfer values (CETVs) should be obtained and early consideration should be given as to whether it is appropriate to instruct a PoDE – a cost/benefit analysis should be conducted and reference should be made to the PAG Report as to what constitutes a set of circumstances where instructing an expert is necessary.

There are various options, but generally separating parties will act as follows:

1.      Share the pension with reference to the income that will be produced;

2.      Share the pension according to the CETVs;

3.      Share the pensions with reference to the capital that is available and the benefits which the pension gives rise to;

4.      Offsetting.

When considering whether to share a pension, the parties should reflect on the following questions:

1.      Will the arrangement provide the parties with enough capital now and in the future?

2.      Will the arrangement provide the parties with enough income now and in the future to meet their needs?

3.      Are there any tax consequences of the arrangement?

4.      Are there any health concerns the parties need to have to regard to? Will the arrangement be impacted on the event of death?

5.      Does either party wish to remarry in the future? Will the arrangement be impacted on the event of remarriage?

Ultimately, legal advice should still be obtained to ensure both parties can move on independently after they are divorced with the confidence proper provision has been made now and for the future.

Annabel Andreou is a solicitor at Debenhams Ottaway debenhamsottaway.co.uk