It’s not uncommon for pension rights to represent a significant proportion of the matrimonial assets. Therefore, dealing with these rights in a way that ensures both parties’ interests are best served may lead to some difficult and acrimonious discussions.
The circumstances of each party may be such that finding a solution that suits both is elusive. Advisers are likely to be approached by the legal representatives of one party with a view to reaching an optimal solution for that party.
By way of an example, consider a scenario where such an approach is made on Paula’s behalf, and the circumstances are that she is in her early fifties, with two teenage children still at school, and has negligible pension savings. Her wife, Emma, 10 years older, has substantial pension savings and these savings, plus the family home, are the two largest matrimonial assets.
In this case the adviser has been asked to outline the options for dealing with the pension rights, highlighting the advantages and disadvantages from Paula’s perspective. In addition, a view on how palatable the options will appear to Emma has also been requested.
There are three ways of dealing with pensions on divorce: offsetting, earmarking, or sharing.
Offsetting
Under this option both parties’ pension rights are unaffected with the value of the pension rights offset against other assets e.g. spouse A has pension rights of £400,000. Marital home worth £500,000 and the couple have other assets of £100,000. The divorce settlement may provide for spouse A to keep the pension rights while all, or part, of other assets pass to spouse B.
In our example, Paula will have custody of the children and it’s likely that in opting for offsetting she would take sole ownership of the matrimonial home, meaning that she and her children would not suffer the upheaval of having to find somewhere else to live and the children would not have to move school.
Assuming she can find suitable accommodation, from Emma’s perspective, this option is likely to be attractive as she would retain the full value of her pension rights, which in the event of her death could pass to her surviving children.
The downside for Paula is that she would have little in the way of pension savings and given her age, lack of other assets and ability to contribute at the necessary level, it may prove difficult to build up sufficient pension funds for a comfortable retirement.
Earmarking
This was introduced by the Pensions Act 1995 and involves a court order directing the trustees of a pension scheme to make payments to an ex-spouse from the date the member draws benefits. All or part of the benefits of one of the divorcing parties are paid to the other party. Orders may be made against a member’s lump sum on death and/or retirement. The crucial point is that the benefits remain in the member’s name.
With our example, from Paula’s perspective, it’s difficult to see any attraction using this option. It does appear to address her lack of pension rights and may be advocated by Emma if the pension scheme doesn’t have readily realisable assets.
However, Paula wouldn’t receive benefits until ex-wife Emma decided to take hers, and their respective plans may differ. Unless death benefits have been included in the order, she would receive no benefits if Emma pre-deceased her.
In addition, any retirement benefits would be lost if she re-marries. These issues indicate a lack of control, and this is further exacerbated by Emma making any investment decisions (the divorcing parties’ attitudes to risk may not coincide). If the divorce has been acrimonious, Emma could also opt-out of the pension scheme and fund for her retirement using a non-pension method to the detriment of Paula’s retirement planning.
There is no clean break under this option, and it’s hard to see it holding much attraction for either party.
Sharing
Introduced by the Welfare Reform and Pensions Act 1999, this necessitates the creation of a pension credit for one party, and a corresponding pension debit for the other as the holder of the pension rights. The creation of which is achieved through a court order or by agreement between the divorcing couple (Scotland only).
Giving effect to a pension credit involves the setting up of benefits for the ex-spouse under the member’s scheme or under a scheme of ex-spouse’s choice. The option(s) for the pension credit will be dictated by the member’s scheme.
For Paula, this option would be attractive in that she currently has negligible pension savings and would acquire a level of pension rights that might be difficult to replicate given her period to retirement. Furthermore, she would have control over access to these rights. Unlike with earmarking if she did remarry these pension rights would be retained. A clean break from Emma would be achieved, which is likely to appeal to both parties.
Under this option, it’s likely that other matrimonial assets would need to be shared, which could be problematic. If the pension rights being shared were under an unfunded public sector scheme, the pension credit would be established under the scheme, meaning that Paula would become a scheme member. The benefits offered under the scheme in respect of the pension credit may not provide the flexibility Paula requires.
From Emma’s viewpoint, this option could have negative pension tax implications. If she held primary protection or one of the forms of individual protection, the pension debit could potentially result in a reduction in the lifetime allowance she has available. The reduction in her pension savings, caused by the pension debit, may require a significant increase in future pension funding to make up any shortfall, and could result in annual allowance issues.
Going through a divorce is likely to be stressful and expensive. Therefore, having legal representation that fully understands the ways of dealing with pensions on divorce and how they interact with their client’s circumstances is essential in ensuring a positive outcome for the client at a cost that provides value for money.
Where the legal representative’s pensions knowledge is lacking, then it is likely that they will turn to their adviser connections for assistance. It’s here that the adviser can add value, as well as potentially inheriting new clients.
