After property, pensions are often the largest single asset to be divided in a divorce proceeding. The Welfare Reform and Pensions Act (WRPA) of 1999 introduced a new pension sharing framework for divorcing couples, but two decades later this continues to be a poorly understood field of family law.
Research conducted by Scottish Widows in 2017 found that seven out of ten couples don’t discuss pension savings1 in divorce proceedings. With divorce lawyers also sometimes uncertain about how to tackle the complex issues, official figures show just 14% of divorces in 2018 included some sort of pension settlement order2. This limited engagement with pension sharing leads to negative outcomes: research by Prudential found that the average expected annual income for divorcees retiring in 2018 was up to 18% lower3 than those never involved in a marriage breakup. And women are especially vulnerable to lost income as they face an estimated £100,000 gender pensions gap4 by the time they reach their 60s.
Amid evidence of a wide variation of settlements across the country, in July 2019 the multi-disciplinary Pensions Advisory Group (PAG) issued a new “good practice guide” 5 for the treatment of pensions in divorce. The PAG noted that problems stem from a lack of understanding of how professionals should deal with the valuation, sharing or offsetting of pension fund assets. This affects both divorcing couples, who are unsure of their rights when it comes to dividing pension assets, and family lawyers, who could be subject to a negligence claim if clients feel as though they were poorly advised. In response, the PAG said it set out to create a guide that “demystifies the jargon of pensions and improves communication amongst the professionals working in this field across England & Wales”.
The Basic Pension-Splitting Framework
The first key challenge when approaching pension sharing in divorce is valuation. Rules may vary depending on where in the UK, but pension assets that can be split typically include all workplace and personal pension schemes, as well as additional state pension benefits (but not the basic state pension).
The standard approach for calculating the total value of pension assets is the Cash Equivalent (CE) method, which essentially states how much a person would get if they moved their pension assets elsewhere. This is a useful method, but the PAG guide highlights some limitations of CE that family lawyers and their client should be aware of. This is most apparent when one or both spouses have a Defined Benefit (DB) pension scheme, which is linked to salary, or more complex public sector pension scheme. In some cases, a full report by financial experts on pension sharing in divorce may be required to ensure an accurate and fair valuation of all assets.
Once information on the total value of the couple’s pension assets has been gathered, there are three main ways to find a settlement:
Offsetting is currently the most common approach to pension splitting, and in effect involves ‘trading’ the value of future pension income for a larger share of non-pension assets today (such as a bigger share of the family home). It is often seen as a relatively simple and quick way to reach an agreement without needed a court order, though accurately comparing the cash equivalent value of pension and non-pension assets can sometimes be difficult. Indeed, the 2019 PAG report found that negligence claims against family lawyers “overwhelmingly related to ill-considered offsetting agreements”.
A Pension Sharing Order (PSO) is issued by a court either as part of a consensual settlement or as a ruling in contested proceedings. A PSO requires one ex-partner to share a certain percentage of their pension plan(s) with the other. This can be done either by transferring the agreed share into the ex-partner’s existing pension scheme, or by allowing one ex-partner to join the other’s pension scheme. The optimal decision will depend on the pension scheme rules and calculations of future tax liability. If the person due to share their pension is already retired and receiving income, while the other ex-partner has yet to reach the age at which they can draw on their pension, a deferred pension sharing agreement may be required.
A Pension Attachment Order (PAO) is less common and gives one person the right to claim a share of their ex-partner’s pension when they start receiving it. This order can be implemented as sharing part of the monthly pension income, the lump sum or both, but will only be triggered when the ex-partner starts drawing on their pension.
The advantages of using one method over the other will depend on each individual case. The key takeaway is that pensions must not be overlooked in divorce proceedings, and sound legal and financial advice is essential to ensure fair outcomes for all parties. This latter point is especially relevant in light of government efforts to approve legislation that would permit ‘no fault’ divorces – that is, without the need for one party to accuse the other of adultery, unreasonable behaviour or desertion – which some experts say could result more ‘DIY divorce’ settlements without specialist advice6.
Gaining a better understanding of the potential benefits, pitfalls and complexities of pension sharing should help divorcees and family lawyers know when to approach specialist Financial Advisors to reach a fair and tax efficient settlement and safeguard against potential claims in the future.
How we can help
As pension experts, we will identify the total value of the pensions and ensure the benefits are split fairly between the two parties following instructions from the divorce lawyer, we will then put this together in a report with our recommendation. This report will be passed to the lawyer or court to decide whether the pension value will be offset or how the final split will work.
If you need support with pension splitting, please get in touch
If you would like to discuss your financial situation, please speak to your financial adviser in the first instance.
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