There has been much press speculation concerning the recently introduced pension freedoms and, specifically, how these have made the issues of pensions and divorce significantly more complicated.
It is important to understand the options that couples have historically had when dealing with pension benefits on divorce, and how these now interact with these pension freedom rules.
There are three ways in which pension benefits can be dealt with as part of a divorce settlement: earmarking, offsetting or sharing.
Earmarking
This was first introduced by the Pensions Act 1995. It is effectively a form of deferred maintenance payment. This is where all or part of the pension benefits of one of the divorcing couple are ordered to be paid to the other spouse.
Offsetting
This is the most straightforward and most commonly used method for dealing with pension benefits. In this scenario, each spouse retains their pension assets, but these are then offset against other assets, such as the matrimonial home.
Pension sharing
Pension sharing has largely superseded earmarking and has been in existence for divorces filed on or after 1 December 2000. A pension sharing order has the effect of splitting the member’s pension by a specified percentage. This creates a ‘pensions debit’ in relation to the member’s pension and a corresponding ‘pensions credit’ for the former spouse.
The recent shake-up in the pensions world means that those over the age of 55 can now cash in their pensions, less a tax charge, and effectively do what they like with the residue. There is no longer a requirement at any age to buy an annuity that would provide a guaranteed income for life.
The simplest and most straightforward option for divorcing couples with pension benefits is to offset their pension benefits against other non-pension assets. If this is not possible, they may consider pension sharing. Both options achieve the ‘clean break’ principle.
These pension freedoms can potentially present a problem for divorcees who have a right, by means of an earmarking order, to an ex-partners’ pension.
Earmarking orders have always potentially been problematic for the divorcee, as the ex-spouse retained control over how the pension was invested and when the pension benefits were taken.
However, they now face a potential additional problem whereby it is possible for the ex-spouse, from the age of 55, to take out the pension in one go, as a lump sum minus a tax charge. Some earmarking orders will not have been drawn up with this eventuality in mind. These could have been written in a way that entitles the divorcee only to a percentage of the income.
