Pension simplification in 2006, and then pensions freedoms in 2015, have changed the face of retirement so significantly that their impact on other areas such as divorce just can’t be ignored.
Technically, there are still three options to deal with pensions in divorce settlements – offsetting, earmarking and pension sharing – but are they all still viable in today’s landscape? All of the options are impacted in some way by the changes we have seen over the last 11 years, so they may need to be revisited if possible. Table 1 sets out the options as they stand.
Offsetting pensions against other assets is the easiest way to deal with pensions in a divorce. Given this has no impact on either party’s lifetime limits or pension protections, it may be the most preferable way to deal with things. However, there are issues that may arise in the case of offsetting today that may well not have been an issue years ago.
The biggest is funding pensions in the future for the ex-spouse with little or no pension. Historically, annual allowance levels went all the way up to £255,000 a year. These levels might have seemed excessive, but when an ex-spouse has received a payment due to offsetting, they may want to contribute as much as possible to a pension as quickly as possible.
The amount they can contribute is now restricted to £40,000, or even less, which could easily be used up if they have cash or assets and don’t need to use earned income.
Earmarking Orders – or Attachment Orders – were the forerunner to pension sharing, and the only option (other than offsetting) prior to the Welfare Reform and Pensions Act 1999. Earmarking Orders were typically drafted to make a lump sum payment or pay a percentage of income to the ex-spouse when the pension was in payment.
The flaw in the system was that the decision of when to draw benefits was at the discretion of the member, (unless it was specified in the order, which was rare) so if the divorce was acrimonious, the member could delay drawing the pension or not draw it at all.
Earmarking Orders ceased on the member’s death or on the remarriage of the ex-spouse. They were drafted at a time when pensions freedoms and flexibility was never envisaged and these new freedoms, such as drawing an uncrystallised fund pension lump sum (UFPLS), or nil income from flexi-access drawdown, can have the unintended consequences of circumventing the requirements set out in the order unless the details in the order are very specific.
In most cases, the order will cease on death, so nothing will be received at that point either. This is because Earmarking Orders simply specify the amount of pension commencement lump sum (PCLS) or income that has to be passed over to the ex-spouse when they are accessed and don’t give a deadline for access.