In the first of a series of three articles looking at how pension benefits can be dealt with in the context of reaching a financial settlement on divorce, we examine offsetting and earmarking
Despite the introduction of pension sharing, a third and potentially more appropriate option for dividing pension assets on divorce, it is still important to understand earmarking and offsetting.
To avoid having to include clumsy alternatives, this article assumes it is the man who has the original pension scheme benefits. Any reference to trustees should be taken to include administrators, where appropriate. Any mention of a personal pension can be taken to include a stakeholder pension, unless the context requires otherwise.
Ever since 12 October 1984, the Matrimonial Causes Act 1973 (MCA) has imposed a duty on the court to take into account all financial resources each party in a divorce settlement is likely to have in the foreseeable future. However, the phrase foreseeable future has sometimes been interpreted as no longer than 10 years, with the result that pension benefits could be ignored by the court if they are not due to commence within that period.
The Pensions Act 1995 ensured pension rights had to be given proper consideration by inserting section 25B into the MCA, which included the wording: 'In relation to benefits under a pension scheme, section 25(2)(a) above shall have effect as if in the foreseeable future were omitted.'
Another feature of the Pensions Act 1995 was the introduction of the concept of earmarking for the purpose of giving a former spouse a share of the pension scheme benefits.
Before we consider this in a little more detail, let us spend a moment looking at offsetting. This was the only means of dealing with pension scheme benefits prior to earmarking and, in many ways, remains the preferred option where feasible. Under this approach, the former spouse without the pension benefit, or with the smaller pension provision, takes other assets of a value comparable to the shortfall. Where there are other substantial assets, the use of offsetting can work well and has the advantage of creating a clean break. Unfortunately, a typical scenario is where the principal assets are just the house and the husband's pension benefits, which does not lend itself to offsetting.
In view of the many occasions when offsetting did not provide a suitable solution, a joint working party was set up by the Pensions Management Institute and the Law Society to consider how best to meet the needs of divorcing couples. A report entitled Pensions & Divorce was published in May 1993, recommending pension rights should be split on divorce, with the former spouse being given a transfer to an individual policy.
Before pension splitting could be introduced, a divorce case known as Brooks v Brooks gave rise to a ruling that Mrs Brooks was entitled to a share of her former spouse's pension in her own right, as a pension benefit. This was specifically forbidden under pension scheme legislation at the time so compliance with the court ruling would have resulted in the pension scheme becoming unapproved. There was therefore an urgent need to amend pension scheme legislation.
Earmarking was the solution chosen by the Government of the day, rather than pension splitting. The necessary legislation was included in the Pensions Act and earmarking became available for all divorce petitions, judicial separations or annulments started on or after 1 July 1996-19 August 1996 in Scotland.
During political debate over the changes to pension scheme legislation, the Opposition party forced the Government to make provision for the later introduction of pension splitting but it was to be more than four years before this came to fruition.
Earmarking gives the ability to instruct the pension scheme trustees to make a payment from the pension scheme directly to the former spouse. In England and Wales, it is possible to earmark both lump-sum and pension benefits but in Scotland, only the lump sum can be earmarked. All or part of the available benefit can be earmarked.
The legislation applies not only to occupational pension schemes but to personal/stakeholder pensions, Section 620 retirement annuities, FSAVCs and Section 32 and 32A contracts. This includes contracted-out rights, protected rights and the so-called section 9(2B) rights, which relate to service after 5 April 1997 in contracted-out, defined-benefit schemes. Earmarking does not extend to State scheme benefits.
Schemes must calculate the value of benefits within three months of receiving a request and provide it within ten working days of making the calculation.
In Scotland, if the benefits began to accrue prior to the marriage, the valuation will be reduced by the court by multiplying them by the period of marriage over the total accrual period up to the date of valuation.
The following problems are associated with earmarking:
• For tax purposes, any pension paid to the former spouse is treated as though it were still the scheme member's.
• Retirement benefits will not be payable until the member's benefits become payable, regardless of the needs of the former spouse.
• Pension payments will cease on the death of the member, subject to any guaranteed period.
• Payments to the former spouse will cease if the former spouse re-marries.
• An earmarking order in respect of a lump sum benefit does not cease on the death or re-marriage of the former spouse.
This last point means that an earmarking order for a lump sum will still be effective if the former spouse pre-deceased the scheme member, resulting in the need to keep open the estate of the deceased former spouse in case a payment becomes due in future.
A copy of the court order must be sent to the scheme trustees, who must take reasonable steps to ensure they are paying the correct person. The former spouse must notify the trustees within 14 days of remarriage because earmarking is seen as a form of deferred maintenance, which ceases on remarriage.
The scheme member may be charged a fee for providing a valuation for earmarking purposes and the costs of complying with a court order may be deducted from the former spouse's benefits.
If benefits that are subject to an earmarking order are transferred, the receiving scheme or arrangement will normally have to accept the earmarking order as well.
Where only part of the rights is being transferred, or the transfer value is being split, the earmarking order will not transfer to the new scheme or arrangement, so the former spouse may have to obtain a further order against the transferred benefits ' yet another problem associated with earmarking.
In the next article, we shall turn our attention to pension sharing, which is available where the petition for divorce or nullity is filed on or after 1 December 2000.
Under offsetting, the former spouse without the pension benefit takes other assets of value comparables to the shortfall.
Earmarking gives the ability to instruct trustees to make a payment from a pension scheme directly to the former spouse.
Pension sharing is available if the petition for divorce or nullity was fixed on or after 1 December 2000.
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