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"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 Divorce & Pensions
- The 3 Options:
- Pension Offsetting
- Pension Sharing
- Weighing these options against each other
Couples going through a divorce may be faced with a situation where their pension, or the pension of a spouse or partner is a major consideration as pension rights form part of the assets when it comes to divorce settlements.
The factors relating to pensions are often complex and there is a threat that settlements are reached where the full range of options have not been properly investigated or analyzed.
Our start point is always the same: couples should ensure they have the full range of options, with the advantages and disadvantages of each, properly mapped out and explained to them. This is not just the case prior to any settlement being reached, but probably, in most cases, before any negotiation towards a settlement takes place. The Court has to take pension rights into account when the couple’s affairs are assessed and a settlement agreed. The rules are the same when it comes to the formal dissolution of a civil partnership. Where we discuss ‘divorce’ throughout this guide, the same points and factors will apply to civil partners.
A pension or pension rights can often represent one of the biggest assets. Indeed in a reasonable number of cases it may be the biggest asset. The issues around pensions for people going through a divorce can often appear perplexing. We aim to provide some simple guidance throughout this guide which will help translate these complexities into easy-to-understand terms. Our guide is not meant to act as a technical document. Anyone in the process of divorce, whatever the current stage who has a pension or their spouse has a pension should seek out professional advice – from a pension specialist.
This is a guide which outlines the ‘top level’ aspects to this subject. Armed with this information and understanding we hope any individual reader will be better set to deal with the all the various aspects they need to consider when they discuss matters with their advisers.
Please note: the laws applying in Scotland vary from those in England, Wales and Northern Ireland. Most of the basics are the same but there are some important variations in how the different payments may be treated, we cover these and all the differences in the section Scottish Law.
The three options:
- Pension offsetting - balancing the pension rights against other assets;
- Pension earmarking - arranging that when one person’s pension comes into payment part of it will be paid to the other person;
- Pension sharing - splitting the pension at the time of the divorce so that both parties get their own pension pot for the future.
Which method will be best in any particular situation will be decided by a range of different factors and could be subject to negotiation
as part of the wider divorce settlement. It is worth stressing that the different options could produce very different outcomes.
PENSION RIGHTS FORM PART OF THE ASSETS WHEN IT COMES TO DIVORCE SETTLEMENTS
It is very important for any individual going through a divorce that they are properly advised which method is likely to work best for them as the decision which to use could have far reaching consequences. To understand how the options compare and the different aspects, we need firstly to examine each option separately:
This where the pension benefits are offset against other assets.As an example a husband has a pension valued at £300,000 and the couple jointly own a house valued at £600,000. Offsetting would allow for the pension to be traded against the house and the husband may keep the pension, the wife the house or some other trade-off based on the respective values. However the pension would remain with the husband, the wife would have no future claim on it or share in it.
Earmarking is an agreement that when a pension comes into payment, a part of it (a set percentage) is paid to the ex-spouse (or ex-partner). The relevant pension scheme provider receives a written instruction from the court to make this payment.
In England, Wales and Northern Ireland, the payment can be taken from a pension and/or cash lump sum. In Scotland, it can only come from the cash lump sum. If there is a lump sum benefit on death in service, this can be earmarked. The court can order all or part of it to be paid to the ex-spouse (or ex-partner), and can order the pension member to nominate them. If an individual has retired and chose to have a guarantee on their pension, this can also be earmarked. The percentage to be paid is set at the time of the divorce, but either party can apply to the court to vary the amount. The percentage is paid when the ex-spouse or partner opens their pension pot.
Pension sharing means that the pension is split (as a percentage) at the time of the divorce. The court issues a Pension Sharing Order, which states the percentage of the pension which is to be given to the ex-spouse or ex-partner. This is worked out as a percentage of the pension’s transfer value. The transfer value is worked out at the day before the Pension Sharing Order takes effect. This means that the value can be higher or lower than the value of the pension stated at the time the divorce proceedings started.
The pension awarded to the ex-spouse or ex-partner is called a pension credit. This can be transferred to a pension scheme chosen by the ex-spouse or partner, as long as that scheme is able to accept the transfer. If the ex-spouse or ex-partner does not make a choice, the scheme or provider may allow them to become members of the existing scheme. Alternatively, they may transfer the pension credit to a buy-out policy (sometimes called a section 32 policy).
If the pension credit remains in the existing scheme, the ex-spouse or ex-partner will receive the increases that the scheme gives to deferred pensions. Schemes can charge a fee for dealing with the administration of pension sharing. Pension sharing can also take place when the pension is already in payment, although the fees may be higher as the process is more complicated.
Weighing these options against each other
There are advantages and disadvantages applying to each method, which may vary in importance purely dependent on the divorcing couple’s circumstances. There is also another factor, not often commented upon: the advantages to one party of one method may be a disadvantage to the other party.
There can be conflicts in the interests of each party which need to be dealt with, negotiated and balanced.
This is such a specialist area that it is likely only a pension qualified adviser will be able to provide the required individual assessment of which method is most suitable.In general terms here are some examples of the advantages and disadvantages of the three methods:
Pension offsetting advantages:
Simplicity: This is often seen as the simplest method – the pension of one party is attributed a value (for example £100,000) and this is retained as an asset by that party, with the other party receiving£100,000 in value from some other asset.
• Ease of administration: the offsetting is easy for both parties to administer, in addition - there is no need for a court order.
Pension offsetting disadvantages:
• One party may end up with little or no ongoing pension benefit: a typical example would be where one party has a high pension value, an offset is agreed leaving the other party with an asset (typically maybe the family home) but no pension entitlement, which could cause problems later down the line.
• Valuations may be difficult to agree and/or
a fair offset achieved: in theory an offset is a simple arrangement, however in practice getting the value of the pension agreed and/or the appropriate split to work can be very difficult. For example a pension may be valued at £200,000 and a property at £1,000,000, offsetting one against the other without selling or sharing the assets in some way may not work in line with the percentage split that one or both parties seek.
• Death benefits from the pension may be lost and this may be detrimental to the ex-spouse.
Pension earmarking advantages:
• Both parties can benefit from a generous pension entitlement into the future: the nature of earmarking favours a situation where the future pension will accrue with both parties able to benefit.
• Pension death in service benefits can be earmarked for the ex-spouse.
• Where a pension is already in payment through an annuity, the ex-spouse can have a proportion of the ongoing annuity payment.
Pension earmarking disadvantages:
• Loss of control for one party: The ex-spouse
is dependent on receiving their pension entitlement whenever their former partner decides to retire. In addition the scheme may change in future years, the member may choose to reduce benefits or even in an extreme case forego the future pension in favour of other means of saving.
• Income on a pension in payment will be taxed at the pension member’s income tax rate: The income from the pension is payable first to the member and only then paid over to the ex-spouse as part of the earmarked court order. This creates a tax charge which is based on the member’s rate, which could easily be a higher rate than the ex-spouse’s, creating an unnecessary tax liability (compared to other options).
• Earmarking ceases on remarriage: should the ex-spouse wish to remarry the earmarking will cease to apply.
• Earmarking ceases on death of the scheme member: the ex-spouse will lose all of his/her entitlement if he/she is pre-deceased by the ex-partner.
• Parties will need to remain in contact to ‘manage’ the ongoing pension situation between them.
Generally speaking the disadvantages of earmarking can be so great and the risks for the ex-spouse so high it has become a largely defunct option, only used when narrow circumstances apply. It is not a ‘no go’ but it is likely in the great majority of cases to be the least attractive option of the three available.
THE DISADVANTAGES OF EARMARKING CAN BE GREAT; THE RISKS FOR THE EX-SPOUSE HIGH... IT’S A LARGELY DEFUNCT OPTION
Pension sharing advantages:
Both parties get a pension: this provides a completely clean arrangement where after the divorce both parties go their separate ways with their own pension entitlement. There is no ongoing attachment.
• Both parties get to make their own decisions after the divorce: As a consequence each party can make their own independent decisions going forward about the investment approach, when to retire and adding further contributions.
• The ex-spouse can remarry without affecting the pension rights.
• Pension income will be payable at the tax rate of the receiving member.
Pension sharing disadvantages:
For high earning individuals who may be affected by the cap of the lifetime allowance, the amount that is transferred to their ex-spouse will count towards their lifetime limit.
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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.