How are pensions split in a divorce? Often the second-largest asset, behind the family home, splitting pensions in a divorce does not need to a question of opening Pandora’s Box but it can be a complex area.
There are a number of ways to share a pension – amongst the options open to the Court are ‘pension sharing orders’ and ‘pension attachment orders’ – but it is important to understand the implications, not just for today but for the future when deciding how to split a pension pot.
Pensions and divorce
Finding a financial settlement when a couple divorces or dissolves their Civil Partnership can be a daunting task. It can involve the consideration of many different assets and a sense of comparing apples with pears.
Very often couples arrange their finances, over many years, without conscious planning. Knowledge of each other’s finances can be limited. Bank account balances are usually transparent and can be shared easily.
In long marriages, the family home has often been lived in for years without checking the current market value.
Spouse’s pensions, however, regularly fall outside people’s financial knowledge. Contributions are made direct from salaries and rarely talked about. Payslips are often electronic and not brought home or shared and annual statements are often consigned to boring admin piles in bottom draws. It is not surprising that pensions have an air of mystery about them especially when people make the brave step to embark on divorce.
How are pensions calculated in a divorce?
Pensions are a rather unique asset. They are often subconsciously treated like a savings pot but the funds cannot be accessed unless the account holder is able to draw a tax-free cash lump sum when they begin drawing their pension. In many cases, this leads to the pensions being treated in the abstract – just numbers on a page.
Those typed numbers are certainly not as black and white as they might appear. Sadly, this can lead to the risky distribution of pensions or the trading of pensions for other assets based on the quoted value. This is potentially catastrophic in retirement and fundamentally unfair for one spouse.
What are the different types of pensions?
There are hundreds of kinds of pension funds. In a divorce, trustees are asked to provide what is known as a Cash Equivalent Transfer Value (CETV). This gives the fund a notional financial value as if it were a savings account. However, simply to accept the valuation ignores the different kinds of funds and the true value both now and in retirement.
Two main types of pensions
Defined Contribution Schemes (DC) – these might be a private fund contributed to over the course of a career. The value of the fund comes solely from the amount contributed or invested over time.
Defined Benefit Schemes (DB) – these are regularly public-sector schemes provided for teachers, medics and the police. They produce a defined income in retirement so long as contributions have been maintained in accordance with scheme requirements. They are often referred to as ‘final salary schemes’.
Comparing DC and DB schemes is not a case of comparing one savings pot with another. The key then is not to be sucked in by the CETV but to focus on the income the fund will generate. That will enable fair division.
How are pensions split in a divorce?
Pensions can be divided quite easily. Just because the money can’t yet be accessed doesn’t prevent us from sharing them. The science is in establishing how much to divide.
A Pension Sharing Order (as part of the financial side of a divorce) provides the instructions to a pension fund to extract a specific percentage from a fund and transfer it either to a different fund (external transfer) or to an account managed by the same fund (internal transfer). This might be the case if both spouses are doctors, for example. Once such an order has been implemented, the parties can usually contribute to this fund, ‘drawdown on’ it (i.e. withdraw money) and generally deal with their pension as they choose to, without impacting on the other party’s fund.
Pensions attachment order
You can receive part of your ex-spouse’ pension, income or lump-sum but only when it starts being paid to them. A pension attachment order shares a percentage of the pension income and/or lump sum but if the pension holder dies, the surviving party’s income from that pension fund will cease.
The value of the pension is offset against other assets. For example, a spouse wants to relinquish a claim over their spouse’s pensions, often in favour of keeping the whole house.
One alternative to pension sharing or pension attachment orders is ‘off-setting’. This is where one party ‘off-sets’ their interest in the other party’s pension against other non-pension assets such as equity in property or bank savings or investments of equal value. When calculating the appropriate ‘off-set’ figure it is important to appreciate that a pound in a pension pot is not the same as a pound in a bank account or even a property. There are various reasons for this, including the fact that there are restrictions on when money in a pension fund can be accessed, both in terms of income and lump sum, and there may be tax to pay on pension income – and in some circumstances lump sum withdrawals as well. It is therefore advisable to seek advice from a pension expert or actuary on how to calculate the appropriate ‘off-set’ figure but even if you choose to take this option you should always remember that you are comparing two different types of assets, one a future income source, the other a more immediately available resource. It is often said that it is like trying to compare apples with oranges.
How do you split a pension if you have already retired?
Even if you’ve already retired, it does not prevent pensions being shared. However, as they’re in payment, they are classed as an asset and an income source and need to be treated carefully. This makes seeking expert advice from a pensions expert and a solicitor all the more vital.
The pitfalls of dividing pensions in a divorce
A pound in a pension fund is not the same as a pound in a bank account or even a property.
It is important to consider this as whilst the pension splitting options above may appear pragmatic and simple, in practice, there is potential to make mistakes, often discovered years later.
For example, if you are considering offsetting a pension for ownership of the family home you are comparing two totally different assets: one a future income source, the other a more immediately available resource. Not so much apples and pears, but chalk and cheese.
The solution to splitting pensions
The answer is to tread carefully. Gather the right information. Take the advice of a Pensions on Divorce Expert/Actuary in conjunction with the advice of your solicitor. You will find Pension Advisers we work with across our offices on The Divorce Directory.
Tackling pensions head-on in a divorce allows for informed decision making, minimisation of risk and leads to fairness and peace of mind.
Getting expert pension advice is crucial
In certain cases, the involvement of a pension expert or actuary will be essential. In particular, cases involving final salary pension schemes, defined benefit schemes and public sector schemes may require an expert’s input into the true value of the pension fund and often a transfer or cash equivalent value can underestimate a fund value. With final salary schemes, where the member can retire after a fixed number of years and often long before the normal retirement age, the full pension benefits paid to an individual who could even be in their early 50’s are far more valuable than the cash equivalent value would suggest. Police, Fire Service and Armed Forces pension schemes, for example, require careful consideration and each pension will be governed by a specific scheme, depending on when the fund was first set up. With the Armed Forces Pension Scheme for example, there are three different schemes, all of which differ in some way and would impact on the value of the pension. In some cases there will be more than one transfer value for a member. It is also important that early departure payments (EDPs) are taken into account where relevant, so a projection of EDP benefits should be obtained.
When reviewing the value of a pension fund, experts will take into account a number of considerations, including the specific benefits of the individual scheme.
The ‘true’ or ‘fair’ value of a pension, may significantly exceed the cash equivalent value provided by the pension trustees. One example I have seen related to a defined benefit pension with Aviva which had a stated cash equivalent value of £18,818. However, the scheme was obligated to pay a Guaranteed Minimum Pension (GMP) at the age of 60 and consequently the ‘true’ comparable value of the pension was considered to be £85,053 and not £18,818!
It is not always a case of concentrating on pension fund values and sometimes, particularly cases involving couples approaching retirement, the projected pension income is more relevant. In such cases it is appropriate to calculate the level of pension share required to achieve equality of pension income for the divorcing couple on retirement, taking into account all of the pension resources.
Given the value of pension assets, and the intricacies of certain schemes, it is important that the right questions are asked on divorce to ensure that the pension resources are divided in a fair way. At Stowe Family Law, our solicitors regularly deal with cases involving valuable and complicated pension assets and regularly work with pension experts to ensure that a fair outcome is achieved.
Get in touch
You can visit our Pensions & Divorce page for further information. If you would like any advice on how pensions are split in a divorce or other family law issues please do contact our Client Care Team to speak to one of our specialist divorce lawyers here.
This article was published earlier and has been updated.