The consideration of pension assets is often a fundamental element of a financial settlement following a divorce or dissolution of a civil partnership.
In many cases, the starting is that pension assets should be shared equally. However, pensions are complicated assets; very often the Cash Equivalent Transfer Value (“CETV”) that is stated on a person’s annual pension statement is misleading in terms of the annual income or benefits that the pension will produce in retirement.
Achieving equality in respect of pensions is therefore not as simple as adding up the parties’ respective pension CETVs and dividing the total figure in half. While in some cases it may be appropriate to divide pensions looking at their capital value, in other cases it may be appropriate to consider equalising the benefits that a pension may produce).
Types of pensions that can be split
The most common types of pension scheme are defined benefit and defined contribution. A defined benefit pension pays you an income in retirement based on your salary and how long you’ve worked for your employer, for example final salary and career average schemes. Many public sector pensions are defined benefit schemes.
A defined contribution pension is a fund that you contribute into throughout your working life (often with your employer matching your contributions) and those monies are invested on your behalf. Upon retirement, most people will use the invested funds to purchase an annuity, providing income in retirement.
Consideration does however need to be given to the type of scheme and the practicalities of achieving a split. For example, a final salary pension may prohibit an internal transfer (preventing the non-member from retaining a fund within the same beneficial scheme) and it generally costs a lot more to purchase equivalent pension benefits on the open market
There are a number of ways in which pensions can be dealt with in a financial settlement – including by way of a pension sharing order, a pension attachment order or a capital/ lump sum order instead of a pension share. These various approaches are dealt with below.
What is pension earmarking/ a pension attachment order?
Historically, the court would divide pension assets by implementing what is known as a pension attachment order, or ear-marking order. Such orders made in respect of a relevant pension will provide that, when the pension is drawn, all or part of the tax-free cash benefit and / or pension income will be provided to the scheme member’s former spouse. These types of orders are now rare as there can be significant disadvantages for most people, however there are cases which this type of order will be appropriate.
What is pension offsetting?
It is also possible for one party to “buy-off” the other party's pension claims – essentially providing the other spouse with additional capital in order to forego their pension sharing order. This approach is known as “offsetting”.
As an example, one spouse may have a pension worth £500,000; we can assume for illustrative purposes that the other spouse would be entitled to receive £250,000 from that pension scheme (albeit as above, the level of pension share required to achieve equality is seldom as simple as dividing the capital value in half). The spouse in possession of the pension may offer to provide their ex-partner with capital in lieu of a pension sharing order.
It is accepted by the court that cash paid upfront is more valuable than cash preserved in a pension which may not be accessed for several years, and so pension off-setting is not conducted on a pound for pound basis. In the above scenario for example it may be that the capital lump sum required to achieve an off-set amounts to say £180,000 - £220,000. It is important to note that offsetting is complex and specialist advice from a pensions on divorce expert/ pension actuary is likely to be required.
What is pension sharing?
A pension sharing order involves a percentage of one party’s pension being transferred out of their existing pension scheme into a separate scheme in the other party’s name. In some circumstances this can be with the same pension provider.
Pension sharing orders are the preferred approach to dealing with pension disparities upon divorce or dissolution of a civil partnership. The primary reason for this is that it achieves an immediate clean break between the couple in respect of pensions. Calculating the correct pension share can be complicated, and specialist advice from a pensions on divorce expert/ pension actuary is likely to be required.
Finding out how much the pensions are worth
To determine how much the pension funds are worth, the first port of call is to request a cash equivalent transfer value (CETV) from the provider.
According to research by the insurance company Aviva, the UK holds £15.2trn pounds in household wealth – private pensions make up around £6.4trn, 42 per cent, of the total.
Aviva’s study also included a survey of 1,000 men and women who have been divorced. It revealed one in six divorced people did not realise their pension could be affected by splitting up. This meant more than a third, 34 per cent, made no claim on their former partner’s pension, according to the survey of more than 1,000 people who have been through a divorce.
Alistair McQueen, Head of Savings & Retirement at Aviva, said “it is critical that, as part of the separation process, couples take time to think about and discuss one of their single most valuable assets, their pension.”
All too often pensions are overlooked, despite being a valuable, even potentially the most valuable asset to consider in the matrimonial pot.
The treatment of pension assets in divorce is a complex issue. If you require specialist advice regarding pension orders, offsetting or any other family law issues please contact a member of our Family Law Team.
