Pension sharing post-freedoms

In some cases this flexibility has helped with the advice process; in others, it has made it more complicated.

Helpful flexibility

David Trenner, technical director for Intelligent Pensions, comments: "Pension freedoms have proved helpful for pension sharing in divorce when liquidity is an issue, and the client is over 55.

"Many households have limited liquid assets and the two major assets are the family home and one or more pension funds.

"If the wife has custody of the children then it makes sense for her to keep the house, but the husband still has to live somewhere."

He adds that taking money from his pension fund could be a solution, although the recently announced reduction of the money purchase annual allowance from £10,000 to £4,000 could be a problem, as the first article in this guide has covered.

Pensions freedoms have made giving advice more difficult - and expensive - because there are more options and, therefore, dangers.Robin Ellison

Pension freedoms have also made the division of defined contribution (DC) benefits on divorce much more simple, according to Mike Morrison, head of platform technical for AJ Bell.

He says: "Post-age 55, it is now easy to share a defined contribution pension on a pound-for-pound basis, therefore facilitating a clean break. 

"Pre-age 55, a pension sharing order will need to be used, although the pension freedoms have not changed the advice requirements around this."

Offsetting, earmarking, pensions sharing orders

Until the Pension Act 1995, the only method of splitting pension assets in a divorce was called 'offsetting'.

This means that, on divorce, non-pension assets were traded to compensate for the loss in pension assets by the other spouse.

According to Alistair McQueen, savings and retirement manager at Aviva, this is "traditionally the most common option as it allows a completely clean break between the divorcing couple".

The value of the pension is taken into account when dividing the assets but each individual keeps their own pension rights.

Specialist financial advisers or actuaries are usually needed to provide a specific valuation but generally, a valuation will take into consideration the age of the pension member, their salary, how long they have been in the scheme and the level of contributions made to the scheme.

For example, according to sharingpensions.co.uk, this would be how to work out average valuations from a private scheme, assuming the pension holder is male, scheme retirement age is 65 and if in service for three years after the pension valuation date. 

If both couples are in similar workplace DC schemes, ascertaining the valuation should be a reasonably straightforward mathematical calculation. 

However, complications arise when defined benefit schemes are involved, with protected rights and guarantees.

As with defined benefit pension transfer requests post-pension freedoms, any advice involving defined benefit pensions by law has to involve a specialist adviser with relevant qualifications if the value is more than £30,000.

Earmarking

For those former spouses without any form of workplace pension - more often than not the female partner who may not have been in full-time employment before 1995 - the need for additional income in retirement from the ex-spouse was recognised in law.

The Pension Act 1995 section 166 introduced a method known as earmarking.

It used to be called a pension attachment order. This is where a spouse would retain the right to a share of the pension when the member retired.

It therefore provides a pension income in the former spouse’s name.

Figure 1: What is pension earmarking? (source: Pensions Advisory Service)

Mr McQueen comments: "This is effectively a form of deferred maintenance payment, where all or part of the pension benefits of one of the divorcing couple are ordered to be paid to the other spouse.

"As with maintenance payments, this option can be complicated to agree and implement."

According to Martin Tilley, director of technical services for Dentons Pensions Management, pension freedoms have added some flexibility for people wanting to do earmarking orders.

He explains: "New options allow a greater flexibility of use of pension freedoms where the division of assets is required."

He provides an example, whereby one partner could be granted an earmarking order for a share of either an income or pension commencement lump sum (PCLS).

The pension holder could elect to draw their benefits as an unfunded pension lump sum (UFPLS), which technically under the word of legislation does not pay a PCLS and by definition, the remaining lump taken simultaneously is not an income.

Mr Tilley adds: "Similarly, the drawing of income under flexi-access allows a flexibility of rate of income drawn."

Figure 2: What is a pensions sharing order? (Source: Pensions Advisory Service)

While pension sharing orders are legally available to couples divorcing throughout the UK, these are not compulsory, although as Mr McQueen explains, "this option allows the pension asset to be divided into two, and one part is legally transferred to the ex-spouse.

"The receiving spouse now has complete control over their part of the pension and may take benefits as and when it suits them. This is commonly seen as the most attractive option, after offsetting."

Pension sharing was introduced by the Welfare Reform and Pensions Act 1999, which came into effect on 1 December 2000.

In part three of the act, parliament referred to a transfer of pension rights within a scheme, from one member to another, and this will require a court order.

It says: "Schedule three (which amends the Matrimonial Causes Act 1973 for the purpose of enabling the court to make pension sharing orders in 1973 connection with proceedings in England and Wales for divorce or nullity of marriage, and for supplementary purposes) shall have effect."

This act also made pension sharing allowances for people whose divorces may have been overseas. 

Couples divorcing in Scotland can reach a pension share agreement by a court order or by completing a registered minute of agreement.

However, in both England and Wales, this can only be achieved by a court order.

What details will providers need to act on a sharing order?

• Full name and details of the ex-spouse, including date of birth, national insurance number and contact details.
• Copy of the final pension sharing order, stamped by the court.
• Copy divorce paper, including decree absolute (England & Wales) or decree nisi or minute of agreement (Scotland).
• Confirmation there's no appeal pending on the pension sharing order. Providers have four months' implementation period to implement the terms of the pension sharing order.(Source: Prudential 'Pensions and Divorce' technical information)

Complicated

While there are more options for people in divorce, thanks to the various acts, plus greater flexibilities thanks to the pensions freedom and choice regime brought into force in 2015, advising on pensions and divorce is complicated.

This is the view of Stephen Chilcott, adviser at Addidi Wealth, who says: "Pensions have always been complicated and will require detailed financial advice.

"This is essential, given the options now available to clients and their implications, as making the wrong decision could lead to legal challenges of existing sharing orders and other effects, such as costs.

"More options is generally a good thing but it is the challenge of the modern financial planning profession to understand these options and advise their clients accordingly."

According to Jessica List, pensions technical analyst for Suffolk Life, because of the additional complexity brought in by the pension freedoms and choice regime, as outlined in the next article in this guide, the need for an adviser is clearer than ever.

She says: "For example, someone subject to a pension debit who is considering ways to rebuild their fund will find it much more difficult now than even a few years ago.

"They'll need to contend with a lower annual allowance, consider whether carry forward is an option, and assess whether they are affected by the tapered annual allowance or money purchase annual allowance.

"There are also more people with lifetime allowance protection now, which could be lost if an investor tries to rebuild their fund. Most people will find this very challenging to navigate without a financial adviser."

Mr Tilley agrees: "The problem with new pension flexibilities is they create situations previously unobtainable and both past divorce settlements and future ones could be complicated by the options now available."

For example, if someone has been granted an income earmarking order, it could be frustrated by the pension holder simply drawing no income at all, and relying on the death benefit nomination for subsequent distribution of remaining funds on death.

Summarising, Robin Ellison, head of strategic development for pensions at Pinsent Masons LLP, says: "Pensions freedoms have made giving advice more difficult - and expensive - because there are more options and, therefore, dangers."

simoney.kyriakou@ft.com