Pensions are often seen as a bit of a mystery, with many people not realising their true value, but in reality, your pension is probably one of your most valuable assets. It is usually the second largest asset in the marriage after the matrimonial home. During a divorce or the dissolution of a civil partnership, the value of your pension assets will have to be taken into account as part of the financial settlement process.
For those couples going through a painful divorce we often see that they just want to get the financial settlement over with and that their irrational thinking at the time, can often overrule the ability to think about the long term and indeed, whether or not they will have enough for their own retirement. It is so important to get this right and not let any rash decisions now spoil your future.
At the start of the settlement process your entire pension assets will have to be identified and valued, which is not always as easy as it sounds if you have multiple pensions between you. Once this is complete and we feel we have a fair valuation, we will help you agree what is to be done with them as part of the financial settlement and there are 3 main options we will look at:
- Offsetting the pension against other matrimonial assets
- A pension attachment order (formerly known as earmarking)
- A pension sharing order
(Note: There are slightly different rules for pension sharing orders in Scotland than there is in England and Wales)
The most important thing to remember is that whatever option is chosen, a fair pension valuation is still key to getting a fair overall settlement.
Offsetting is the simplest method as this means that the pension is retained by the party whose name it is in and is offset against other assets or by payment of a lump sum to the other party to ensure that the pension fund remains intact.
If there are not enough assets in the matrimonial pot to offset and a lump sum cannot be raised there will need to be a Pensions Sharing Order.
Attachment order (earmarking)
This is an option that is very rarely used but it is an option.
An attachment order is an instruction from the court which requires the trustees of a pension scheme to pay benefits directly to an ex-spouse/civil partner, rather than the member.
The order may be made against one or more of the following pension benefits:
- The pension commencement lump sum (also known as tax-free cash)
- The member's pension
- The spouse/civil partner's death-in-service lump sum
Attachment, which was introduced as 'earmarking' under the Pensions Act 1995, can be useful in that the spouse/civil partner can rely on an independent and trustworthy third party to make the payments, rather than an often reluctant ex-partner, however there are also several drawbacks which mean that it is usually the least often used option.
The main drawbacks are:
- The order only comes into effect when benefits are taken, as this is the member's decision it can be delayed to suit them (even if they are just being difficult).
- Similarly, the member can choose the format of benefits, so if the order applies to the PCLS, the member can choose not to take it (unless specifically directed otherwise in the order),
- The order prevents a clean financial break, since the ex- spouse/civil partner must keep in touch, at least with the scheme trustees, in order to benefit.
- Any pension benefits will be taxed as belonging to the member. This is particularly onerous if the member is a higher rate taxpayer and the ex-spouse/civil partner is not.
- The order may lapse in the event of the member's death or on the remarriage of the ex-spouse/civil partner
- Earmarking orders are notoriously complicated to draft with many being unworkable.
Pension Sharing Order
A pension sharing order has the major advantage over an attachment order as it allows a clean break.
Under a pension sharing order the pension asset is divided into two, and one part is legally transferred to the ex-spouse. Any percentage of the fund can be transferred and this is usually calculated by considering all of the funds each party has available and looking at the other assets and how they have been divided. To be calculated accurately an actuary should be instructed.
The receiving spouse will then have complete control over their part of the pension and may take benefits as and when it suits them (within the pension legislative that applies at the time).
There are three ways in which a sharing order may be implemented:
- The ex-spouse may be offered a transfer to their own pension plan
- The trustees may choose to offer both options
- The ex-spouse may be offered membership of the pension scheme, although this is very rare.
Note - this decision lies with the trustees and applies at scheme level, other than option 3 individual scheme members are not allowed to choose which option they want.
In practice, the trustees of unfunded pension defined benefit/final salary arrangements will want to avoid having to pay monetary amounts out of the scheme and will only offer scheme membership, and trustees of funded arrangements probably want to avoid looking after benefits on behalf of unconnected third parties and will only offer an external transfer.
Since December 2000 sharing has commonly been considered the most favourable option after offsetting.
We urge couples to make sure they seek financial advice before any agreement is made because if you get this wrong, you could lose out in the future. For example, if you have been the main carer for your children and a career break has meant that you have not contributed much to your own pension, it is important that this is taken into account. Also, if you are the person giving up a share of your pension, then you need to be sure that you don’t need any additional provisions for your own retirement. Whatever your situation we can help. With an experienced legal and financial team on your side, all of your options will be considered and together we can make sure the outcome is the best it can be, for now and your future.