An Ultimate Guide to Pensions in Divorce

Introduction:

Coming to a fair and equitable financial agreement is one of the most challenging areas of divorce proceedings, but it is also one of the most important. For many separating couples, making sure the finances are dealt with accordingly is second only to ensuring the best outcome for their children.

In principle, financial agreements are straightforward: you find out what the matrimonial assets are, you assess the needs and rights of each party and divide the assets accordingly – usually with the explicit intention of dividing shared assets more-or-less equally. In practice, things can get more complicated.

One of the more complicated asset types that is up for discussion in financial proceedings consequent on a divorce is the pension. Yes, your pension is considered an asset in divorce court, and it is liable to sharing between yourself and your former (or soon to be former) spouse. This guide will answer all your questions about the process:

• Which pensions are eligible for discussion in divorce proceedings?
• How are pensions valued in divorce proceedings?
• What is a pension sharing order?
• What are the other options for sharing a pension?
• You ask, Blanchards answers: some FAQs

If you’re feeling a little overwhelmed, take comfort that you’re in good company – many legal professionals are also uncertain about the finer points. In 2019, the Pensions Advisory Group (PAG) conducted an important piece of research, A Guide to the Treatment of Pensions on Divorce.

The authors of the report warned that many legal professionally were guilty of “generally misunderstanding the entire pension sharing process.” They also noted that private pensions were present in 80% of divorces, but in only 14% of these cases did they put a pension sharing order in place.

However, don’t be alarmed by these facts. We’ll give you a comprehensive understanding of how pensions are treated during divorce proceedings in plain language, empowering you to make more informed decisions in regard to your own separation.

Which Pensions Are “On The Table” In Divorce Proceedings?

The short answer is “all of them.” Regardless of how different pensions may be dealt with, it is vital that both parties in a divorce give an honest and comprehensive account of their assets, called a “financial disclosure.” This is so that everyone involved can make informed decisions about what constitutes a fair division of assets between the couple in the divorce.

The two most relevant ways to categorise pensions which you possess are private (including workplace) pensions vs. state pensions, and defined contribution pensions vs. defined benefit pensions.

Private pensions are a form of savings plan for your retirement, where you and / or your employer contribute money over time. Private pensions could be either defined contribution or defined benefit pensions.

In defined contribution pensions, also known as personal or stakeholder pensions, you will contribute a certain amount of money each month (and, if it is workplace pension, your employer will also make contributions). This money is then invested, tax free, into various assets. So, the amount of money you’ll receive upon retirement is uncertain; it depends on factors such as the amount contributed, the length of time the money is invested, and how well the investments perform. These are, increasingly, the most common type of workplace pension in the UK.

Defined benefit pensions, however, offer a fixed amount in retirement. They are typically workplace pensions set up by your employer, and often referred to as ‘final salary’ or ‘career average’ pension schemes. Unlike defined contribution pensions, the amount you receive at retirement doesn’t depend on investment performance but rather on the scheme’s rules. These rules usually consider factors such as salary and length of service. Although these pensions were once common, they are becoming rarer due to the financial risks they pose to the providers – if the underlying investments in a pension scheme don’t appreciate as much as expected, pension providers are required to provide the agreed-upon compensation anyway.

The state pension is a regular payment you can claim from the government once you reach the state pension age (currently 66 years old, although it is set to increase). It’s important to note that your basic state pension cannot be shared if your marriage or civil partnership ends, but that does not mean its value can’t be included in financial agreements (see the section What Are The Other Options For Sharing A Pension below). Additionally, in some cases, a divorcee can use their former spouse’s National Insurance contributions to grow their basic state pension.

As well as the pensions listed above, there are some other, less common, pensions you might hold that you will need to divulge in your financial disclosure:

Public sector pensions are typically defined benefit schemes provided to employees of the public sector, such as those working for the NHS, Civil Service, and Armed Forces. The six largest public service pension schemes in the UK are for the Armed Forces, the Civil Service, NHS, teachers, police and firefighters. They provide pension benefits based on salary and length of service.

A self-invested personal pension (SIPP) is a type of personal defined contribution pension scheme that gives you more flexibility with the investments you can choose. It also allows you to manage your own investments, making it a good choice for people who are informed about investing. SIPPs can be opened by anyone in the UK under the age of 75.

A small self-administered scheme (SSAS) is similar to a SIPP, but instead of being set up for one person, they are generally set up for a small number of senior staff in a company. These are often company directors or senior executives, but SSAS’s can also be open to other workers and even family members. SSAS are a specialised type of employer-sponsored defined contribution pension scheme that, like the SIPP, allows greater flexibility of investments and personal choice over where your money is invested.

In addition to the pension types above, you might also have an additional state pension – an extra amount of money, on top of your basic state pension, from the Government. You will be eligible for this if you’re a man born before 6 April 1951 or a woman born before 6 April 1953. The amount you get depends on how many years you paid National Insurance, your earnings, and whether you’ve contracted out of the scheme or not.

How Are Pensions Valued In Divorce Proceedings?

The value of a defined benefit pension, as related to divorce proceedings, is called the Cash Equivalent Transfer Value (CETV), and it must be requested from your pension provider.

The CETV represents the lump sum value that the pension provider would give to another pension arrangement if you decided to transfer your pension. It’s important to note that the CETV may not reflect the true value of the pension benefits, and this is one of those areas where legal professionals would generally employ the assistance of a financial specialist or accountant to ensure no errors were being made.

For public sector pensions, such as those for the NHS, Civil Service, and Armed Forces, the scheme administrators will provide the CETV. Public sector pensions are usually unfunded, meaning the CETV does not represent a pot of money but rather the cost to the scheme of providing the benefits, but for our purposes here it operates the same as any other CETV.

For defined contributions schemes, the process is far easier: the value of the pension is simply the amount of money in the pension pot. And once again, you should speak to your pension provider to obtain this valuation.

SIPPs and SSASs are valued just the same as any other defined contribution pension – the value of the pension is the market value of the investments held within the schemes. However, the sometimes-unusual range of assets included in these pensions, and the bespoke nature of the schemes, mean that this is another case where we would often consult a financial specialist or accountant.

Pensions that are held abroad will come under their own national rules and regulations, and as a result, their valuation can be more complex than pensions held in England and Wales. In these cases, we would once more seek to employ the services of a specialist to ensure an accurate valuation.

Your state pension can’t be split during divorce. However, under the old system (pre-April 2016) you could have already built up your state pension and now be earning additional state pension. If you are in this position, then the court could decide the additional National Insurance payments you have made can be used to increase your soon to be ex-spouse’s state pension. They will lose this benefit if they remarry or enter into a civil partnership before reaching the state pension age.

Once the cumulative value of the pensions has been determined, the courts will consider how to divide them. This is typically done through a pension sharing order, where an order of the court is used to divide one pension into two.

What Is A Pension Sharing Order?

The most common way to deal with a pension during divorce proceedings is the pension sharing order. In almost all cases, this is the simplest, fairest, and most transparent way to divide a pension between two parties.

A pension sharing order is a legal decree used to split pension assets, and it’s an important part of many divorces – even amicable ones. This is because, unlike other assets such as the family home, pension schemes require a court order to make the necessary changes. A pension sharing order cannot be implemented without a Final Order being made on divorce.

Simply put, the pension sharing order specifies how much of the pension in question the ex-spouse is entitled to receive. In England and Wales, the amount is expressed as a percentage of the transfer value(s) of the pension(s) that are to be divided.

Pension sharing legislation was introduced in December 2000 to ensure that people who would otherwise be left almost entirely without retirement benefits were being properly looked after. In the past (and still in some cases today) it was not uncommon for both partners in a relationship to rely on the same pension. Pre-2000, In the eventuality that such a relationship broke down, the person who was not named as the member of the pension scheme could be at a significant disadvantage. This is particularly the case since retirement savings can be the next most valuable assets after the family home.

The process of issuing a pension sharing order begins with formal divorce proceedings, and full financial disclosures from both parties. As explained earlier, this is where you and your ex-spouse both submit documents regarding all your pension arrangements.

Once the value of these assets is calculated, a fair division can be discussed. This might be a 50-50 split, but it could also take other matters into consideration (such as the earning potential of each party). In any case, the objective is usually to ensure an equal income in retirement for both parties.

Once this has been decided, if the transferee’s pension scheme allows transfers, funds from the pension member will be moved into their plan. More commonly however, a new pension is created in the name of the created for the non-member, which they set up with an Independent Financial Advisor (IFA). The amount awarded is referred to as a pension credit, and the amount deducted from the other party is known as a pension debit. The court will instruct your pension provider to implement these plans.

It’s important to note that only the court  can make pension sharing orders. In some cases, particularly for younger couples with more modest pension funds, a pension sharing order may not be appropriate. However, this is something that you should discuss with your solicitor.

Pension sharing orders can provide a clean break between you and your ex. Once pensions are divided up, or a new pension is created for the receiving spouse, you won’t have to worry about it again.

What Are The Other Options For Sharing A Pension?

In situations where pension sharing is impossible (such as with a state pension, which cannot be split) an alternative route must be used to ensure pensions are handled fairly. In England and Wales, the two other options are pension offsetting and pension attachment.

Pension offsetting, like pension sharing, provides a clean break between two parties in a divorce. It treats a pension as a single asset, the value of which is offset against other assets of the same or similar value. For example, if one person has a large pension pot, the other might keep the house (assuming it has a similar value). It’s important to note that it can be difficult in some situations to divide assets fairly with this method, as pensions are different to the majority of assets. It may be many years until their value can be realised (if the couple that are divorcing are not near the retirement age) and in many cases their value is more likely to fluctuate over time. Assuming a pension continues to grow, it may end up being far more valuable than the assets it is offset against.

Pension attachment orders (also known as pension earmarking) is the other alternative. A pension attachment (or earmarking) order redirects part or all of one party’s pension benefits to the other party when it’s paid. This doesn’t provide a clean break for the divorcing couple, and actually forces them to stay in contact. This is because the pension still belongs to its original holder, but some form of payment has to be made to the ex-partner when benefits become payable. The court can order that the ex-partner receives one, or a combination, of the following benefits: all or part of the member’s pension income, all or part of the member’s tax-free cash lump sum, all or part of any lump sum paid in the event of death (i.e.: death in service benefits).

Both pension offsetting and pension attachment orders have their pros and cons. Offsetting allows for a clean break and keeps things simple, but one person might be left with little or no provision for retirement. Attachment orders allow both the tax-free cash and the pension income to be shared, but they can force couples who would rather not see each other anymore into protracted discussions and, in some cases, lifelong contact. The major disadvantage is that the pension attachment order dies with the member.

You Ask, Blanchards Answers: Some FAQs

“What’s the best way to deal with a pension during a divorce?”

We believe that the easiest and simplest route for most divorcing couples is the pension sharing order. A fair division is decided upon, then an order is sent from the court to the pension scheme mandating that a percentage is paid to the pension member’s former spouse. This can either be paid directly into an existing pension, or if the former spouse has no existing pension, this asset can be used to create one.

A pension sharing order can guarantee that both parties have an income in retirement, unlike pension offsetting (where one party gets an asset of equal value, such as a home). Yet at the same time, a pension sharing order allows the divorcing couple to have a clean break, unlike a pension attachment order.

The only time we would recommend using a different mechanism to divide a pension is when a pension sharing order is inapplicable or not cost effective. For example, if one partner has a foreign pension, then it is beyond the jurisdiction of British courts. In this case, pension offsetting would be the right solution. Or, if the couple divorcing is very young and the pension very small, it may be more cost effective to offset it than pursue a pension sharing order.

“Will I have to go to court?”

No. Pension sharing order or pension attachment orders can be achieved by consent and lodged at court without having to set foot in a court building. Pension offsetting doesn’t require a court order, and so can be accomplished via other routes, but again, you should always lodge a court order; a ‘Consent order’ to ensure all claims between you and your ex are dealt with finally by a judge.

“Will I need an accountant to help me figure out valuations?”

The complexity of pension valuation is dependent on exactly what type of pension is under discussion. However, you can rest assured that we will enlist the expertise of accountants and other finance professionals whenever it is necessary.

As pensions are highly specialised financial products that are subject to regulation, and because they can have a variety of possible scheme rules and / or underlying assets held within them, we will always take advice when needed. Solicitors cannot advise on financial products or services. We can also work alongside your own financial advisors if you would like them to be involved in the process.

“What role does a pension actuary play in divorce proceedings?”

A pension actuary can play an important role in divorce proceedings, and are almost always brought in to advise when there are large or complex pension arrangements. Actuaries are often instructed by the divorcing couple to help decide on what percentage of the pension should be transferred to one party.

There are other scenarios where it’s generally recommended that professional advice is sought regarding the division of pensions. These include situations where there are pensions with public sector defined benefit schemes, where couples have a significant age gap, where low value pensions have guarantees which mean they generate benefits as if they were higher value, and where a total combined pension pot exceeds £100,000.

It might also be appropriate to seek expert advice when a case is based on separating out pre-matrimonial pension accrual and post-separation pension accrual. This is where one party is arguing that what has been acquired before or after the marriage should be excluded from division.

“Will interest rates affect the division pensions in my divorce?”

Rising interest rates can have a significant impact on the division of pensions in divorce proceedings. Over the last couple of years, the rise in interest rates has affected the value of cash equivalent transfer valuations. This, in turn, can affect the value of how much pension is transferred.

There will also be a delay between the date of a pension report and the making of the pension sharing order. In addition, pension trustees have three months to implement the pension sharing order. Inevitably therefore, the value of the pension can change. Interest rates can also have an effect.

“Can I change my mind about a pension sharing order after it’s made?”

Not usually. Once a pension sharing order has been implemented, it is quite difficult to undo it. However we at Blanchards Law are pension specialists and have been involved in two recent cases where we managed to reverse pension sharing orders after the funds had already been transferred.

Parting Advice

Going through a divorce and financial settlement can be a stressful experience, especially when there are complex assets to divide, such as pensions. It is important that you don’t let this stress get the better of you. As we hope this guide has shown, sharing a pension is often simpler than you might think, but it’s almost always important.

If you’re going through a divorce and pensions might be on the table, you should get legal advice straight away. Be open and transparent with your lawyer, and make sure you are comfortable that you have all the expertise you need, financial as well as legal. This is an area in which your lawyer can help, as they will have had to work alongside financial specialists before.

If your situation is particularly unusual, or you have any questions about pensions in divorce that aren’t answered by this Ultimate Guide, then please feel free to get in touch with us. Our friendly team of legal experts will be more-than happy to discuss your situation.