"Wealth is not his that has it, but his that enjoys it"
"Wealth consists not in having great possessions, but in having few wants"
"Time is the most valuable thing a man can spend"
- Laertius Diogenes
"The glow of one warm thought is to be worth than money."
"I don't care too much for money for money can't buy me love"
- The Beatles
"Simple, genuine goodness is the best capital to found the business of this life upon. It lasts when fame and money fail, and it is the only riches we can take out this world with us."
-Louisa May Alcott, Little Men
"And though I have the gift of prophecy, and understand all mysteries, and all knowledge, and though I have all faith, so that I could remove mountains, and have not charity, I am nothing."
"Not he who has much is rich but he who gives much"
"Life is what happens to you while you are busy making other plans"
"I pity that man who wants a coat so cheap that the man or woman who produces the cloth shall starve in the process"
A Guide to Considerations for Pensions and Divorce
- The Pension Freedom legislation introduced in 2015
- The Lifetime Allowance
- State pension
- Death benefits
- The difficulties of valuing a pension
- The different issues before retirement as against after retirement
- Court orders & Scottish law
Factors and Considerations
The Pension Freedom legislation introduced in 2015
New rules were introduced in April 2015, allowing pension investors to freely access their pensions in a completely different way to before. These new rules have generally become known as “Pension Freedom” as it expresses the nature of what an individual can do with their pension, which they could not before. In technical terms these new rules have not altered the legislation in the context of pensions and divorces. However, there may be legal challenges to come down the line which could impact case law. That remains to be seen. Whilst the rules around divorces and the options available to divorcees with their pensions by and large are unaffected by Pension Freedoms, there are some practical implications which arise, which need to be noted.
Offsetting is most likely to take place where individuals aim to achieve some form of parity between the value of the pension asset and the value of other assets. Pension Freedoms can offer significant tax and potentially estate planning advantages for those who utilise the new rules, which could have an effect on perceived values when the offsetting negotiation is taking place. The greater flexibility – arguably – offers more “value” to a pension investor than before as they have better ways available to them to organise how they access their pension.
Put bluntly a pension investor could now bludgeon their pension, taking it all out on one day as a cash sum (with tax deducted) which could have a significant impact on the application of earmarking orders. If the order is not highly specific then this does open the door for a pension holder to avoid the terms of an order which is intended to earmark ongoing income, as an example. This complicated by the technical nature and, to some extent, by the terminology.
Pension investors can opt to take all benefits as an uncrystallised funds pension lump sum (UFPLS). If the earmarking order doesn’t specifically mention “tax-free lump sum” or “PCLS”, the pension investor can take the UFPLS (which doesn’t pay a PCLS). There is then nothing left in the pot to “crystallise” (as it is known) and there is no income. These examples of the issues that have now arisen are simply intended to highlight the confusing nature of the position that now exists with earmarking orders. The reality is that in many cases even unsatisfactory orders (ones that are not especially specific or well-worded) may still work as intended, because the Pension Company has an obligation to fulfil the requirements of the order and between them and any disadvantaged party there may well be a variation of the order applied for, to correct the position. However there is no doubt that the earmarking option has become clouded as a result of the Pension Freedom legislation, which may have an effect on divorcing couples.
Pension Freedoms now open up the possibility that the non-pension owning spouse may prefer to have cash rather than a share of their spouse’s pension fund, where the pension holder is age 55 or over. This is made possible, regardless of the age of the non-pension owning spouse because it is the age of the pension holder that is relevant. Where the pension holder is 58 and their spouse is, say, 48 this is possible, even though the latter is under 55. As with earmarking this becomes murky in its application in the real world, due to the nature of the tax position this could lead to (for the pension holder) and also could have a negative effect on their ability to make further contributions. So, although feasible, it does present challenges.
The Pension Freedom rules tend to present practical challenges rather than outright technical challenges and simply strengthen the case for the highest quality and specialist advice to be sought, to cover the position in its entirety.
The Lifetime Allowance
The Lifetime Allowance is the limit an individual faces on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – and can be paid without triggering an extra tax charge. If it is exceeded there are tax charges. The lifetime allowance was introduced in 2006 at a level of £1.5 million. It has been increased since but then subsequently reduced to a current figure of £1.0 million (although it will be increasing in tax year 2018/19 to £1,030,000 in line with CPI). As with other areas of the pension rules the way this allowance affects pension and divorce considerations varies considerably depending on individual circumstances and the route pursued. Put simply, with offsetting it really has no bearing.
Where there is an earmarking order the total benefits, pension and tax-free cash, including payments to be made through the order to the ex-spouse, are assessable against the pension owner’s lifetime allowance and for their income tax liability - regardless of the fact that a portion of the benefits will be paid to the ex-spouse. The amount the ex-spouse receives under the earmarking order, including income, payments are tax free.
This can cause significant problems for the pension investor where an earmarking order is sought and the lifetime allowance is relevant or could become relevant. In the case of pension sharing the complications escalate where the lifetime allowance is a factor. It is worth noting that in many cases, the lifetime allowance is subject to ‘protection’ which means an individual can apply to have the value of the benefits they have built up protected from tax charges. Individuals who have previously applied for protection could have done so at a time when the allowance was a higher figure. The details of protection are not for this guide, but suffice to say, the way the lifetime allowance and protection works when a pension sharing arrangement is agreed is highly complex.There are instances where the value of the debit created by the pension sharing reduces the value of the pension for the pension holder and this, consequently, reduces the amount of the sum for the purposes of the lifetime allowance.
Likewise, the pension credit, increases the value when considering the ex-spouses lifetime allowance. Then the way any protection, previously applied, is affected – also varies! In most cases, pension sharing is actually quite favourable in terms of the lifetime allowance calculation as it effectively spreads the total pension value, on divorce, between two people, rather than one (and each one has a lifetime allowance). However as with all other factors, the position should be analysed first by a specialist.
The basic State Pension is not included in pension sharing schemes or earmarking orders. However one partner may be able to claim a basic state pension through their ex-partner’s national insurance. This would only apply to the years they were together as a couple, and would not affect the ex-partner’s State Pension. This entitlement would be lost if they re-married before they reach official State Pension age.
There is however also the additional State Pension, which can be shared in a financial settlement through the making of a pension sharing order. This means that part of the value of an additional State Pension earned could be shared with a former husband, wife or civil partner. The court will need the details of any additional State Pension entitlement. The Additional State Pension is an amount an individual may be entitled to in addition to their basic State Pension. It is based on National Insurance (NI) contributions and earnings since April 1978. A lump sum valuation will give this information and will help the court make a decision. If a pension sharing order is made, the additional State Pension may either increase or decrease, depending on the decision of the court.
Although a pension scheme is first and foremost a retirement savings arrangement, there will be a value on death that the spouse would have been entitled to during marriage. Therefore on divorce the death benefit will still apply should the pension member die before they draw their pension. How this is treated post-divorce and the effect this will have on each party is going to be a consideration.
The loss of the ‘insurance’ this provides could be very detrimental to the ex-spouse.
Both parties will need to consider what impact the death benefits attached to the pension
will have on their future positions and that of children or other beneficiaries.
This could be influential in deciding which of the three options of dealing with the pension
The difficulties of valuing a pension
This is an exceptionally important consideration. A pension value is not necessarily set in stone. In simple terms there are only two types of pension: defined contribution schemes and defined benefit schemes. A defined contribution scheme, such as a personal pension run by an insurance company or a SIPP, will have a value based on the underlying value of the assets or funds held. This value is reliable, although there may need to be some attention paid to whether any penalties (for early encashment) are included and these may need to be factored in. However more often than not a defined contribution scheme is valued at the underlying value, so if the assets/funds are worth £100,000 then the pension value can reasonably be said to be £100,000.
However with defined benefit schemes there are no such simple assumptions. A defined benefit scheme does not have a value, it has an entitlement. The most common example is the Final Salary Scheme: here the individual has a future pension entitlement based on their salary at retirement date. For example they may be entitled to 1/60th of their final salary for each year employed. For the purposes of a divorce settlement this entitlement may need to be turned into a cash value, which is known as a Cash Equivalent Transfer Value (CETV).
The CETV is a calculation which is open to variation depending on the underlying assumptions made. We will not go into the fine detail here, the complexities are too great for this summary and overview. However it is possible that two experts looking at the same pension arrangement for someone in a defined benefit scheme could come up with two very different CETV figures. This is an essential point to grasp, because normally the CETV is provided by the administrators of the scheme and there is nothing to state that this cannot be checked, analysed and then, if required or appropriate, questioned or challenged. There are so many variables in calculating a CETV including whether discretionary pension benefits have been included, what discount rate has been applied, what the expected earnings escalation are likely to be for the spouse who has the pension, amongst many others.
The different issues before retirement as against after retirement
A reasonable proportion of divorces take place after retirement. There are different considerations to be made if a pension is already in payment. All three of the available options remain viable in some way, but the way that the offsetting, earmarking or sharing can be arranged will vary post retirement than pre-retirement.
Offsetting is a way of dealing with the pension that doesn’t need the involvement of the court; parties can agree their offset without a court order. The other two methods however require the court to make an order to support the intended outcome. In the case of pension sharing this is because the pension provider or scheme cannot act to divide a pension arrangement without a direction from the court. These court proceedings do not have to be contested as in the majority of cases the parties have come to an agreement through their solicitors and only require a consent order from the court. The same applies with earmarking - the provider must make a special provision to record the earmarking attachment as this will not be implemented until the scheme member’s retirement age and this process is ratified by the court order.
COURT PROCEEDINGS DO NOT HAVE TO BE CONTESTED... WITH THE MAJORITY OF CASES REACHING AGREEMENT THROUGH THEIR SOLICITORS
Scottish Law around divorce is quite distinctive, especially with regard to the overall process. Our guide is concentrated on pension’s issues, not the wider ones. In this respect we simply wish to bring forward that the considerations for parties divorcing under Scottish Law and how they view their pensions could be quite different. Just to highlight one example: Scottish Law only considers the pension benefit built up during the time of the marriage (or civil partnership). Where a CETV (the pension ‘value’) is obtained, in Scotland it is then proportioned based on the length of time of the marriage. This is different to English Law where the whole CETV is taken into account.
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The importance of getting professional advice
Arguably the issues and complexities involved with pensions in a divorce make this the most significant area of financial planning for individuals, where obtaining specialist, qualified advice is a ‘must’. Having an appropriate, suitably qualified expert working alongside the legal advice is likely to be worth its weight in gold. Here are some of the main advantages a pension’s expert will be to offer in these situations:
- They will be able to help weigh up which of the three options it is best to pursue. They can present the advantages and disadvantages of each option, based on personal circumstances and requirements.
- The adviser can assess the value of any pension, especially check and evaluate a CETV.
- They can advise an individual who sees their pension entitlement fall as a result of earmarking or a pension sharing order, including how to rebuild lost benefits.
- They can help an ex-spouse assess whether or not to keep a pension with the existing company or to transfer it, when a pension sharing order is made.
- They can assess any loss of death benefits and how these should be replaced.
- They can weigh up the complexities arising from the Pension Freedom legislation and also any that come from the Lifetime Allowance.
- They can help assess the post-divorce finances of an individual facing divorce.
- They can help with wider matters than simply the pension considerations: including post-divorce investment advice where an individual receives a lump sum payment.
- They can look at the individual’s financial planning goals generically and ensure that all family members (including children) are properly catered for.
Readers should not rely on, or take any action or steps, based on anything written in this guide without first taking appropriate advice. Interface Financial Planning Ltd cannot be held responsible for any decisions based on the wording in this guide where such advice has not been sought or taken.
The information contained in this guide is based on legislation as of the date of preparation and this may be subject to change.