What you need to know about pension sharing

An analysis of the data surveyed between 2014 and 2016 reveals the average divorced woman will have a pension worth £131,000, compared to £454,000 for an average married couple.

Additionally, some 12 per cent of married women surveyed said that they plan to rely on their spouse’s pension during retirement, and 17 per cent of married women surveyed had no pension of their own at all.

While a woman may be entitled to claim a portion of her spouse’s pension in a divorce if, for example, her spouse’s work or family life had impacted her ability to work and save, pension sharing is a laborious, time consuming, and costly process and should not be approached lightly.

Divorce is a challenging and stressful time for all involved…the emotional toll is only half of it Emma-Lou Montgomery, Fidelity International

While a spouse may have expected to share their partner’s pension in retirement, pension sharing arrangements are not always resolved amicably.

“Divorce is a challenging and stressful time for all involved…the emotional toll is only half of it,” says Emma-Lou Montgomery, associate director at Fidelity International.

“While giving some thought to what you would need in retirement, should your marriage break down, admittedly isn’t the most romantic of things to do, it’s important to be realistic.”

She adds: “Aside from making arrangements early on to ensure both parties are protected, partners who continue to work can also help boost their partner’s pension by making contributions for them during any time off work.”

To ensure your divorcing clients' finances, and chances of building up their retirement savings, are not adversely affected by the divorce, it is important to understand what the different pension sharing options and what they can deliver.

Splitting retirement savings

Because rebuilding a pension fund following a divorce can be difficult, one of the very first things to consider is what party has the most scope to rebuild their pot following divorce.

“For many couples, their pensions are highly valuable assets – often more valuable than the family home,” says Paul Falvey, tax partner at BDO LLP.

So agreeing how pensions are dealt with on divorce proves vital to the financial future of both parties.

Mr Favley adds: “As pension assets must be taken into account and will be part of the final settlement, cooperating over asset allocation can save both parties money as it allows assets to be dealt with tax-efficiently.”

However, unlike many other assets, he notes there is also “a swathe of tax legislation to be taken into account when sharing out pension assets”.

Cooperating over asset allocation can save both parties money Paul Falvey, BDO 

When it comes to splitting pensions, there are different rules depending on if it is a defined benefit or defined contribution pension.

While rules prevent individuals from accessing DC pension funds until age 55, there may be no right of access until much later for individuals with a defined benefit scheme, points out Mr Favley.

He says: “But it might be possible to access benefits earlier than this by arranging for transfer to a personal arrangement but this may not be possible or sensible.”

Also, if a pension of one spouse is already in payment, he suggests options for the other spouse are likely to be more limited.

It is also important to ensure that any pension sharing arrangements do not trigger adverse tax issues for either party in the future.

Mr Favley explains: “For example, forcing an ex-spouse to take a large lump sum from their DB pension as part of a ‘clean break’ cash settlement could trigger the money purchase annual allowance rules, restricting that spouse’s ability to build up pension rights post-divorce. 

“Or in the worst case, if a spouse with a large unprotected pension has to withdraw a significant lump sum, there could be a benefit crystallisation event triggering an immediate lifetime tax charge at up to 55 per cent.”

He adds: “Where one spouse has a large pension – near or above the £1.055m lifetime allowance – and the other has a small one, a pension sharing order could effectively equalise pension rights meaning that a lifetime allowance charge is unlikely to arise in future.”

Sharing options

In practice, the greater the pension assets, the more likely it is that they will be split as part of divorce proceedings, according to Nigel Cayless, associate director at Sackers.

So understanding the value of any pension benefits in the context of any other matrimonial assets and debts is another key initial step in deciding how to split pensions.

He explains: “In divorce/dissolution proceedings, pensions are valued using the ‘cash equivalent transfer value’ – that is, the amount the member would get if he or she transferred his or her pension to another arrangement.”

What follows then is one of the following pension sharing options:

• Pension sharing orders
• Pension attachment orders (or earmarking in Scotland)
• Pension offsetting
• Individual agreements

Pension sharing orders offer a clean break approach, according to Mr Cayless.

He explains: “The aim is that the capital value of the pension benefits is divided between the parties with the member’s benefits being reduced by a ‘pension debit’ and a ‘pension credit’ of the same amount being granted to the ex-spouse. 

“This will be specified as a percentage of the value of the member’s pension rights rather than a fixed cash amount unless the order is made in Scotland [where earmarking is still an option].”

Pension earmarking, which used to be available throughout the UK but is now only available in Scotland, allows the courts to make an order requiring a part, or all benefits (except the state pension) to be paid to their ex-spouse or ex-civil partner once they become payable.

Mr Cayless continues: “Once the pension sharing order is implemented, each spouse will have their own independent pension rights.

“The pension sharing provisions apply to almost all types of private pensions and to active, deferred and pensioner members.”

He adds: “The only significant exceptions to this in practice are the state pension and pensions received as a dependant.”

A pension attachment order, which replaced earmarking in England, Wales and Northern Ireland, is when pension benefits can be used to pay either maintenance or a capital sum from a pension scheme to the ex-spouse on the member’s behalf.

The key difference to note between attachment and earmarking orders is that in attachment payments can be made from the member’s pension income and/ or the pension commencement lump sum, but with earmarking in Scotland, they can only be made from a pension commencement lump sum.

Mr Cayless says: “[With attachment and earmarking] the ex-spouse will not have his or her own independent pension rights – there is no clean break – [and] his or her rights under an earmarking/attachment order only becomes payable when the entitlement arises under the pension scheme in respect of the member.”

He notes that payments will stop automatically on the death of the member. 

“In practice, earmarking orders against pension payments are only likely to be made where the court deems that a clean break is not possible,” he adds.

Additionally, he says there is also pension offsetting, which involves each party retaining their pension assets but offsetting these against other matrimonial assets.

“For example, if one person has a large pension pot, the other may receive the house, assuming it has similar value,” says Mr Cayless.

He says: “[But] the difficulty with offsetting is that it can be hard to compare values of different assets. 

“It will be particularly difficult to accurately value pension benefits for this purpose if a party has a final salary or other salary-related pension benefits.”

He adds: “As an alternative, a couple could come to an informal financial agreement which they then ask the court to approve and turn into a court order. 

“Such an arrangement would not have a direct impact on any pension benefits.”

victoria.ticha@ft.com