Divorcing couples should make the most of changes to pension rules, says Gary King
New pension rules that came into force in December 2000 mean members of divorcing couples are now entitled to take up to half their spouse's pension pot. This could mean a hefty divorce settlement, as pension benefits are considered to be the largest of the matrimonial assets, and often valued higher than the marital home or the couple's investment portfolio.
Until now, divorcing couples could demand pension rights be taken into account in any cash split, but pensions money could not be touched. At best, pension rights could be 'earmarked' and claimed only after someone's ex-partner retired. From 1 December 2000 pensions can now be split, allowing an ex-spouse to take part of their partner's pension benefits and put it into their own pension plan.
For divorces filed on or after 1 December 2000, there are now three ways in which pension benefits can be divided: offsetting, earmarking, and sharing/splitting. For many divorcees, the changes have resulted in a confusion of their full pension entitlement.
All valuable matrimonial assets are added together, including any property, savings, investments and pension arrangements. The court then decides how this is to be split between each spouse, offsetting the values of each asset in the fairest and most amicable way. For example, there may be a property valued at £50,000, savings and investments worth £20,000, and a pension valued at £70,000. The court may decide that the total assets are to be split 50/50 with one spouse keeping the property and the savings and investments with the other spouse keeping the entire pension.
The problem with this method is that there may not be sufficient assets for this to work, and the pensionholder may end up with no house, and an asset that cannot be touched for a number of years.
Earmarking is when part of an individual's pension fund is set aside for the benefit of the ex-spouse. This is achieved with a court order on the administrator/trustees of the pension arrangement by the judge in the divorce case. This would instruct the pension scheme that, when the member's benefits come into payment, a certain percentage should be paid to the ex-spouse instead. This percentage would depend on the judge's ruling, and can be any amount up to 100% of the benefits.
The ex-spouse then has to wait until the pension-holder takes the benefits before they can receive any pension from the scheme. The pensionholder controls the pension until retirement, and can actually delay retirement if he/she wishes. Meanwhile, the ex-spouse has to remain in touch with the member and scheme, updating them of any change to circumstances.
In respect of divorces that were filed on or after 1 December 2000, a third option is now available. Pension sharing or splitting solves the problem of the assets held within a pension fund at divorce. It is also intended to help offer a 'clean-break' resolution to divorce settlements, which was one of the biggest downfalls of 'earmarking'.
As the name suggests, the pension benefits are shared or split at date of divorce, with the ex-spouse immediately obtaining a pension benefit. This may be in the form either of a cash equivalent (transfer value, which the ex-spouse can move to their own plan) or a pension credit of membership into the member's scheme, with the credit equal to the appropriate pension share as per the divorce settlement. Under either route, the member receives a matching reduction in benefits.
The pensionholder obtains a value of the pension and this is then split in accordance with the court order. The percentage of the pensionholder's fund is then offset against their pension benefits as a 'debit', with the ex-spouse receiving a corresponding 'credit'.
This 'pension credit' is tax-relieved pension money, so it can't be taken as a cash payment ' it has to go into a tax-approved plan as a lump sum and be invested for growth. The tax-approved plan may be a separate pension account in the spouse's scheme/plan, requiring a contract with its manager/administrator, or it could be a private plan where taken out independently with a different manager, or an occupational scheme.
Wherever pension credit goes, the rules of the relevant plan or scheme have to be observed, such as no pension payments until the age of 50. But there are rights too: particularly to take part of the fund built up from pension credit as a tax-free lump sum when ready to draw benefits.
It is evident that this break is squeaky clean. The ex-spouse's share is theirs absolutely and is wholly unaffected by anything the scheme member does, such as dying before the ex-spouse does. And if the ex-spouse dies before retiring, the fund accrued with the 'pension credit' would pass to their 'nearest-and-dearest', not the scheme member.
The scheme member is now short of a major part of their pension fund, although the post-divorce contributions paid in will be unaffected by the divorce settlement. A major pension re-building program may commence, but the 'pension debit' does not count as a reduction when looking at Inland Revenue maximum benefits. Therefore, an individual who has been in an occupational pension scheme for 40 years and may have expected to retire on the maximum two-thirds pension, may find this vastly reduced due to a divorce settlement.
When assessing the pension benefits, the relevant values depend on where you file for divorce, either in England and Wales or in Scotland.
In England and Wales, all pension benefits that have accrued to each party up to date of divorce are taken into account in a divorce settlement. In Scotland, it is only the pension benefits that have actually accrued during the marriage that are taken into account. Benefits accrued by either party before the marriage, or since the divorce was filed, are excluded from the settlement.
To give an example: Mr and Mrs Bloggs are getting divorced. They have a property valued at £200,000, savings and investments of £80,000 and he has a pension fund of £120,000. They have been to court and the court have decided that total assets are to be split 50/50.
With offsetting: The court has decided that the total assets will be split 50/50. It is then decided that Mrs Bloggs will receive the property (£200,000) and Mr Bloggs will receive the savings and investments and keep his entire pension fund (£80,000 and £120,000).
With earmarking: The court asks Mr Bloggs to obtain a Cash Equivalent Transfer Value (CETV) for pension benefits accrued to that date. Mr Bloggs obtains this from the trustees/insurance company, which is calculated by an actuary. The pension scheme or company has to provide this within a three-month timescale.
Once the court has the CETV, they issue a court order to Mr Bloggs to be served to the pension scheme or insurance company confirming that 50% of this pension fund is to be earmarked for Mrs Bloggs. This order remains on these benefits until Mr Bloggs retires, whether he transfers to another pension plan or other type of pension policy. No matter how many times the funds are transferred or where they eventually end up, the court order still applies.
Mrs Bloggs cannot get any access to her portion of the benefits until Mr Bloggs takes retirement. He can be difficult and not retire until 75 or invest in bad funds. If Mrs Bloggs were to re-marry, she would not be entitled to any of the benefits. If Mr Bloggs were to re-marry, Mrs Bloggs would still be entitled to 50% but as before, would have to wait until he retires. The court order will lapse upon Mrs Bloggs' re-marriage or the death of Mr Bloggs.
The problems that arise from earmarking are:
l There is no clean break after the divorce ' both parties are still involved.
l Mr Bloggs has total control of the pension and can therefore defer retirement, chose a bad company and invest in bad funds
l Mrs Bloggs will receive nothing if Mr Bloggs died
l The entire pension is taxed as the Mr Bloggs and Mrs Bloggs portions are paid after tax has been paid
With sharing: Again, the court asks Mr Bloggs to obtain a CETV for pension benefits accrued to that date. Mr Bloggs obtains this from the trustees/insurance company, which is calculated by an actuary. The pension scheme or company has to provide this within a three-month timescale.
Mr Bloggs has then received a court order that his pension is to be split 50/50. This results in a new pension plan been created for Mrs Bloggs and this receives 50% of the cash equivalent transfer value. Mr Bloggs' pension then shows a debit of the value that has been transferred to Mrs Bloggs. Her pension will have a credit against it.
This results in both parties having an individual plan. They can then control their own funds, retirement date, can transfer from pension to pension and have no contact with the other spouse at any time. The only real problem that is attached to splitting is if they are an older couple, they do not have as much time to add to their pension to provide a sufficient income at retirement.
New Pension Rules
The new rules bring pension rights into line with other financial matters in terms of how they are dealt with in divorce proceedings. If a clean break is achieved and a spouse acquires their own rights, exercisable on retirement, they will be in a much better position to plan their own financial future. Pension scheme rights are often the most valuable asset of a divorcing couple and with 40% of all marriages ending in divorce, the new rules are likely to be widely used.
l Pension scheme rights are often the most valuable asset of a divorcing couple.
l New rules on pensions and divorce came into force in December 2000.
l Benefits can be divided either by offsetting, earmarking or splitting.
‘Promising lead’ or ‘Back to the lab’?
PA360 2019 revisited
Complaints triple in past year
Our weekly heads-up for advisers
Tracking real performance