Chairman and partner in our leading Family law team, Brenda Long, explains how pensions are dealt with in a divorce.
Pensions are an asset which can, and should, be considered in any divorce settlement, even though they are often not immediately accessible. Pensions accrued during a long marriage can be a very valuable asset and it is important that they are given careful consideration and addressed as part of the overall settlement in a way which achieves a fair outcome.
What are the options?
Pensions can be dealt with in one of three ways in a divorce settlement:
- Pension Sharing Order - a Pension Sharing Order transfers a percentage of a pension from one spouse to a pension held by the other. Orders can be made against more than one pension.
- Offsetting - offsetting is where one spouse receives a greater share of the liquid assets in order to ‘offset’ their claims on the other’s pension(s).
- Pension Attachment Order - this is an Order which requires a percentage of a spouse’s pension income and/or lump sum to be paid to the other spouse once they start drawing the pension.
In our experience, pension sharing orders are the most common way of dealing with pensions in a divorce settlement, but research into court orders suggests that offsetting is the most popular approach. However, this may be because divorcing couples who do not obtain legal advice do not know about/consider pension sharing and/or understand the value and importance of pensions.
What are the issues?
Pensions are initially valued by reference to their Cash Equivalent Value. However, this value cannot be directly compared to other assets, eg property or cash. Pensions cannot be accessed until you are at least 55. There can be tax benefits when paying into a pension, but tax consequences when drawing money out. So £1 of cash is not the same as £1 of pension. This makes it difficult to decide what is a fair amount of other assets to offset, or partially offset, claims on pensions.
Also pensions are valued in different ways, depending on whether they are defined contribution pensions (pensions derived from investing cash over a period of time) or defined benefit pensions (pensions derived from years with an employer and based on final or average salary). These valuations are not directly comparable with each other as defined benefit pensions are generally worth far more than defined contribution pensions of the same value. Therefore you cannot simply add the values together and divide by two.
Pension Attachment Orders can address pension disparity on retirement, but create issues if the spouse with the pension dies before they draw it, which is likely to leave the other spouse without sufficient pension provision.
What needs to be done?
In most cases, a pension report should be obtained from a pension expert – either an actuary or IFA with the appropriate expertise. This report will set out the options and state:
- Whether offsetting is a viable option and, if so, what figure would be required to offset pension claims.
- What pension sharing would be required to achieve the desired aims – usually equalisation of pension income at a specified date – and how this can best be done to maximum income for both spouses.
- Whether either spouse might exceed their pension Lifetime Allowance and how this can be addressed.
A pension report can take a while to obtain, but if the need for one is identified early on, any delays can be minimised. Such reports are not inexpensive, but they provide piece of mind that pensions have been considered and dealt with in a fair way and that no-one has ‘sold themselves short’.
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This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.