The value of pensions and investments and the income they produce can fall as well as rise. You may get back less than you invested.
Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.
Tax treatment varies according to individual circumstances and is subject to change.
Are pensions split between spouses in a divorce?
Much depends on the circumstances of the individual case and what the two parties agree to, but pensions are often considered matrimonial assets and therefore split in a divorce.
Sharing a pension on divorce is a complex area, especially if the divorce is acrimonious.
Each party should take professional advice from a divorce solicitor on top of financial advice, especially when there’s a pension involved.
Divorce and the state pension
Some elements of the state pension may also be split in a divorce. Although the basic state pension can’t be divided in a divorce, any additional state pension benefits, such as SERPS or the second state pension (S2P) can be split on divorce or dissolution of a civil partnership through a pension sharing order.
An ex-spouse or civil partner can also use their former partner’s National Insurance contributions to increase their state pension for the years they were married. Both of these rights are lost when they remarry or enter a new civil partnership.
The new state pension, brought in during recent pension reforms, cannot be shared between former spouses and civil partners. This is because it is paid at a flat rate to all.
Until the Pension Act 1995, the only method of splitting pension assets in a divorce was ‘offsetting‘. Effectively, offsetting sees non-pension assets traded off to compensate for the loss in pension assets by the other spouse.
The method introduced by the Pension Act 1995 was known as ‘earmarking’ – where a spouse would retain the right to a share of the pension when the member retired. Pension earmarking has since been renamed as a pension attachment order, although both terms are widely used. While pension attachment orders have their benefits – namely providing a pension income in the former spouse’s name – it also has its disadvantages.
Waiting to receive my ex-spouse’s pension…
The ex-spouse must wait for their former spouse to start drawing their pension to receive their share, the timing of which may not suit the ex-spouse. The courts have no power to dictate when the spouse with the pension begins drawing an income from it, what age they should work to or even if they should continue making contributions to the scheme earmarked by the court.
The Welfare Reform and Pensions Act 1999 introduced a third option: a ‘clean break’ option known as pension sharing. This allowed a complete split of the pension benefits because benefits were transferred into an entirely separate pension arrangement in the ex-spouse’s name.
How are pensions split for a divorce?
Due to the devolution of certain areas of law in the UK, the rules are slightly different depending on where the spouses live.
In England and Wales and Northern Ireland, all assets built up by each individual – including pension assets – up to the date of the separation are taken into account when calculating total matrimonial assets. In Scotland, however, only assets built up during the marriage are used.
Pension Specialist at Drewberry
Court orders are needed to divide a pension
Pension funds can only be divided by a court order as they were set up with only one beneficiary in mind: the person saving for a pension. However, if the couple decides to offset the pension with other matrimonial assets this does not require a court order as the pension remains in tact.
The courts may be more likely to agree to a pension split if there is a significant imbalance between the pension savings of the two parties. This could be because one of the couple has been the breadwinner, while the other has worked part-time or not at all (perhaps because they’ve taken care of the family and home).
How much each party could get is dependent on individual circumstances, and if both parties already have similar pension provisions in their own names then the courts may rule that pension assets don’t need to be split at all.
Divorce and final salary pensions
Defined benefit schemes can complicate the sharing of pensions in a divorce and will require additional analysis and expertise. This is because the member’s pension entitlement is a promise from their employer and is not reliant on investment returns or annuity rates. It may also be linked to their final salary, which is hard to determine at the time of the divorce, especially if the couple is young.
This specialised analysis work adds an additional expense to the overall cost, especially if the member is enrolled in more than one defined benefit scheme. The member must also consider the financial ramifications of transferring out of the defined benefit scheme to split the pension entitlement with their spouse. Doing so might be giving up a guaranteed retirement income.
Some final salary schemes, especially public sector schemes, may allow the non-pension holder to become a pension sharing member in the event of a divorce. Speak to your scheme or ask a pensions expert about this option.
Any shortcuts or failing to seek professional financial advice with these types of schemes will almost certainly be costly in the long term. Importantly, you should apply to the relevant providers and seek some pension advice from a financial adviser. This will enable you to consider all options earlier rather than leaving the pension assets to last because they are a lower priority.
Offsetting pensions in divorce
Offsetting is the oldest method of sharing a pension in a divorce. Marital assets are traded to offset the loss in pension benefits by the other spouse. So if there is a pension fund worth £200,000 and a property also worth £200,000, the spouse with the pension would keep it in tact but sign over the property to the spouse without any pension provisions to make up for the loss.
Issues with offsetting pensions
Pension offsetting is useful if the pension is inaccessible, such as when it’s based offshore. However, there are a number of problems with this approach. It’s difficult to make assumptions of a future benefit from a pension fund and compare those with assets such as property and cash transferred at the date of the divorce.
For the pension holder, the issue then arises that although they may have retained valuable pension rights during the split, they won’t have access to property/savings that was used to offset their pension pot. They could be left with a pension pot that they may not be able to access until retirement and not much in the way of other assets.
Offsetting is not as simple as taking the value of the pension fund at the date of separation and compensating the spouse with the equivalent in cash and property.
Complex actuarial calculations are required to determine how much the spouse would have benefited from the pension pot.
Pension Specialist at Drewberry
Women live longer than men, for instance, so would likely be receiving a pension for longer than a former husband. This must be taken into account when determining the assets the spouse without the pension gets to compensate for the loss in pension rights.
Offsetting still could see one partner having little or no pension provisions and limited independent earning power to rectify this in time for retirement, given that the additional share of assets they receive may not easily be liquidated and put into a pension fund. This might be the matrimonial home that serves as the residence for any dependent children.
Offsetting large pensions
Also, if the pension is particularly large, it may leave one party with a pension they can’t touch until retirement and few other viable assets, if indeed there are sufficient matrimonial assets to cover the size of the fund in the first place.
The issues with pension offsetting were a notable driver of the legislation in the Pension Act 1995 on the splitting of pensions in divorce.
Earmarking pensions in divorce
Under a pension attachment order, benefits are retained by the member of the pension arrangement. So if one partner’s pension was worth £10,000 per year and the other partner was entitled to 50% of this, they’d receive £5,000 of pension income.
The earmarking order can be applied separately to one or more the following:
- Pension income
- Tax-free lump sum
- Death benefits.
This option carries the following associated risks:
- The ex-spouse receives their proportion of their pension entitlement only when the member starts taking their pension benefits, but the courts don’t have the power to stipulate when this should be.
- The member is within their rights to delay drawing their pension past the scheme’s normal retirement age; there is nothing to compel them to start taking the benefits so the partner can begin receiving theirs
- The order will lapse if the ex-spouse remarries
- The order will lapse if the member dies.
People delay taking their pension for many reasons, such as not being able to afford to retire – this may be related to the splitting of assets in the divorce if it occurred later in life – or simply not wanting to yet.
Choosing when to draw a pension
The member may not want to start drawing on their pension because, while they’re still working, taking additional income would push them into a higher tax band. Also, investments may have underperformed, and the member could be waiting for them to recover.
In addition, the member may choose to defer taking benefits because the marriage breakup was particularly unpleasant or they feel that the amount paid to their ex-spouse was excessive.
If the member has accumulated other assets after the divorce or retained them in the divorce settlement, then they may be able to comfortably retire without the pension income, leaving the ex-spouse waiting for their share.
Pension attachment orders and remarriage
Although earmarking address some of the issues regarding pension sharing in divorce present in offsetting – namely it doesn’t leave one spouse without pension provisions and the other with few assets other than a pension – the approach is clearly not without issues of its own.
Pension attachment orders make no provisions for the circumstances of both parties changing over time.
Pension attachment orders cease on remarriage, but more than 1 in 5 of the men and women who entered into an opposite sex marriages in England and Wales in 2013 had previously been divorced.
It may also not be practical or desirable for the former spouses to remain in contact with each other, making a ‘clean break’ approach is the most preferable and practical solution in most cases. A clean break may be the only sensible solution if, for example, one party wishes to start a new life abroad.
Divorce Pension Sharing Order
A pension sharing order offers more of a clean break solution than is offered by a pension attachment order, and also addresses many of the other issues related to the previously discussed methods of splitting a pension after a divorce.
If you opt for pension sharing, the court will issue a pension sharing order which sets out how much of your pension scheme(s) your ex-partner is entitled to receive. This figure is a proportion of the transfer value of the scheme or schemes to be divided. The court may also rule on the proportion of the final benefit from the scheme your partner is entitled to.
Awarding pension credits
The pension awarded to the former partner will be in the form of a pension credit, which can then be transferred into an existing pension scheme or a new one set up to receive the transfer. In most cases, the only option on the table will be what is known as an external transfer, with the transfer value payable to a scheme nominated by the ex-spouse outside of the member’s own plan.
The other option is less common and applies to some defined benefit schemes. Known as shadow membership, it involves the ex-spouse receiving a ‘pension credit’ based on the member’s entitlement.
So if the ex-wife was entitled to a pension of £10,000 per year and the court orders 50% of this to be transferred to her former husband, then the ex-wife’s benefit from the scheme is reduced from £10,000 to £5,000 and the ex-husband receives a ‘credit’ in his name from the scheme of £5,000 per year.
Pensions that can be shared in divorce
The following arrangements can be shared:
- All ‘money purchase’ pension arrangements
- including personal pensions, stakeholder plans, executive pensions, occupational money purchase schemes, small self-administered schemes (SSAS), retirement annuity contracts (section 226), buy-out plans (section 32) and AVCs
- Defined Benefits schemes (including care average and hybrid schemes)
- State earning related pension scheme (SERPS) and state second pension (S2P)
- Compensation schemes
- Pension Protection Fund and Financial Assistance Scheme
- Deferred benefits and benefits in payment
- Pensions in payment
- Scheme pensions, annuities and drawdown plans.
Pensions that can’t be shared in divorce
The following types of pension can’t be shared in a divorce:
- Basic state pension
- Graduated retirement benefit (second-tier state pension)
- Widows pension benefits from a previous marriage
- Pensions already subject to an earmarking order.
Under a pension sharing order, all pension benefits are calculated as a ‘capital value’. For money purchase arrangements this is simply the transfer value and for defined benefits schemes the cash equivalent transfer value (CETV) is used.
Due to the overall costs in implementing a pension sharing order, this option is only viable for pension funds of significant value.
The associated fees payable to cover the cost of the analysis work and implementing the pension sharing order are:
- Solicitor fees
- Adviser fees (and actuarial fees) for the pension calculation work
- Scheme fees to implement the sharing order
- Many pension schemes charge a fee to implement a pension sharing order and to administer it if both partners remain invested in the fund
- Public sector defined benefit schemes will likely charge for the CETV figures, and the costs can be quite high.
Managing multiple pension pots and divorce
The ‘job for life’ mentality has long passed and people now change jobs an average of 12 times during their career. This means that a couple could have accumulated significant wealth over a number of pension arrangements, an issue that will become more prominent over the next few years as auto-enrolment includes most people in some form of pension scheme.
Although a pension sharing order is fairly simple if there’s only one personal pension arrangement, most couples will have a number of arrangements between them, some of which may be defined benefit schemes. Having numerous pension arrangements creates complexity to the decision process because:
- Each scheme may have different rules on how the pension credit is implemented
- Each scheme will have their own fee structure for implementing the pension sharing order
- For defined benefit schemes, the transfer value may not truly reflect the benefit given up and therefore an alternative valuation may need to be calculated using a pensions expert and an actuary, which could be costly to do more several schemes
- The court must decide which schemes the pension sharing order should apply to
- One or both halves of the couple may already be receiving their pension benefits.
Order, order: Pension attachment order or pension sharing order?
It’s impossible to say which option is right for divorcing couples splitting a pension without looking at the case beforehand as it’s dependent on the individual circumstances surrounding each separation.
However, a pension sharing order can have a number of benefits over pension attachment orders. These were brought in specifically to address some of the issues that earmarking can create.
Pension Adviser at Drewberry
Benefits of pension sharing order…
A pension sharing order provides the former spouse with a pension arrangement in their own name which they could then invest as they wished to suit their personal needs. Earmarking leaves all the power in terms of attitude to risk with the spouse who held the pension prior to the divorce, meaning they may choose a risk profile at odds to one their former spouse would have chosen.
Sharing order provides you with control
Similarly, a pension sharing order gives each party separate control of the desired level of income they’d like in retirement, whereas a pension attachment order only entitles one spouse to a percentage of the member’s pension entitlement set by the court. They can’t take any action to increase the actual income from the fund and therefore the size of their share.
A pension sharing order offers a clean break for each party because both have their own respective pensions that they can decide to leave to whoever they see fit in the future. A pension attachment order, meanwhile, is revoked on remarriage, which may see individuals not getting married again for fear of losing their pension entitlement.
Better planning based on personal circumstances
By splitting the pension pot into two separate entities, the two former spouses can better plan for issues such as a longevity mismatch (women tend to not only live longer than men but also be the younger partner in opposite sex marriage, for instance) and differences in their health.
A party expecting to have a longer retirement can make the necessary adjustments to their arrangement to ensure this is affordable, whereas this is not the case under a pension attachment order. If one half of the former couple is in poor health, a pension sharing order enables them to buy an enhanced annuity and take other measures to ensure they can cover the cost of future care requirements.
How are pensions valued for a divorce settlement?
It’s easy to value most matrimonial assets other during a divorce. The family home, cash savings and cars are all simple to put a price on. However, pensions are harder to put a value on. Although a pension provider can offer you the transfer value of an existing arrangement, this value may not be representative of the perceived value of the benefits accrued by both parties.
To return to the earlier example in the offsetting section, is a £200,000 property worth the same as a £200,000 pension arrangement? This is dependent on a number of factors.
How easily can the house be sold at the valuation provided, and what are the selling costs? Is it possible to realise the value in the house straight away? Perhaps one half of the couple will continue living there with any children and can’t sell it immediately; will house prices have fallen in the future when they are in a position to sell?
How do you value a pension in divorce?
When valuing a pension during a divorce, you need to take into account each party’s age. Are they over 55 and thus able to access the pension arrangement with a 25% tax-free lump sum under the new pension freedoms, or are they younger and is pension planning therefore less important?
What will the income tax liability be on the income element of the pension, and how much can be taken as a cash-free lump sum? Is the CETV for a defined benefit pension a realistic value of the benefit being given up?
What if one half of the couple wants cash to hand? Funds held in a pension arrangement can’t be easily liquidated for non-pension purposes, such as if one of the former spouses wants to put down a deposit for a new house.
All these questions make it clear why valuing a pension is a difficult business and requires the input of experts. They will be able to take all of these factors into account when valuing your pension in a divorce. The end benefit is often a higher consideration than the value of the fund at the time of the divorce.
Divorce and pensions: statistics and facts
- According to the Office for National Statistics, the number of people getting divorced in England and Wales has fallen from an all-time high of 165,018 in 1993 to 106,959 by 2016.
- This is likely because the number of people getting married is also fallen; each of the years 2006-2009 saw the lowest number of opposite sex marriages in England and Wales since 1895.
- Yet the divorce rate isn’t falling for those aged 60+. 9,848 men and 6,128 women aged 60 and over got divorced in 2016. For men this is an increase of 38.5% since 1996 and for women the number has almost doubled over the same period.
- Being divorced is increasingly common – 3.8 million people in England and Wales were divorced in 2016, up from 3.4 million in 2006.
- Cohabitation has become far more common as an alternative to marriage – and cohabitation offers none of the same rights to partners’ pensions in the event of a breakup. 4.6 million people in England and Wales were cohabiting having never been married or in a civil partnership in 2016, up from 3.5 million in 2006.
- A further 1.3 million people who had previously been married or in a civil partnership were cohabiting in 2016.
- In opposite sex divorces, women are still more commonly awarded shares of their husband’s pension than the other way round. This is because lower workforce participation among women due to their spending time out of work raising children and taking care of the home means they are less likely to have significant pension arrangements of their own.
- However, this is changing – while only just over half (52.7%) of women worked in 1971, 70.8% did by 2017, the highest figure since records began.
- As the proportion of working women grows and wives become more financially independent from their husbands, and auto-enrolment offers them their own pensions, there could be fewer orders made for pension sharing in opposite sex marriage due to each party being on more equal footing.
Getting advice on pensions in divorce
If you are currently in the process of getting divorced and would like to discuss your specific situation with one of our specialist pension advisers then please email us at firstname.lastname@example.org or call us on 0208 432 7333.
Alternatively, if you are a solicitor looking for pension analysis on behalf of your client we are able to assist.