The part of the pension given away to the ex-spouse will be shown on the member's scheme records as ...
The part of the pension given away to the ex-spouse will be shown on the member's scheme records as a 'pension debit', and the ex-spouse will receive a 'pension credit'.
In a final salary scheme, the debit will be referred to as a 'negative deferred pension'. It is very likely that a member of a final salary scheme may have several different 'tranches' of pension accrual. A 'typical' final salary scheme may have a GMP element, pre-April 1997 non-GMP right and Reference Scheme Test (RST) benefits. The debit must contain a pro-rata slice of each different tranche. Therefore, if the debit is for, say, 50%, it must have 50% of the GMP, 50% of RST benefits accrued to date, and 50% of pre-1997 non-GMP benefits and so on. Where the ex-spouse's credit includes GMP or RST benefits, or protected rights from a money purchase arrangement, these are classed as 'safeguarded rights' which are subject to broadly the same conditions as protected rights.
For the purpose of calculating the Inland Revenue (IR) maximum allowable pension from an occupational scheme, the debit will, for most members, continue to be counted as part of their pension. This will preclude some well-funded individuals from rebuilding the gap in their pension, which many will view as unfair, particularly if the debit is a significant part of their accrued pension. From the trustees' perspective, this will involve complex record keeping. The IR eventually granted a limited concession in this area by introducing what it refers to as an 'administrative easement'.
Individuals who are not controlling directors and who earn less than a quarter of the earnings cap (currently £22,950) in the year of assessment immediately preceding the year in which the marriage dissolution occurred need not count the debit as part of their pension for IR maxima purposes.
When comparing against IR maximum benefits for occupational money purchase schemes, the debit will be treated in the following way. The amount deducted from the fund on divorce will be recorded and increased between the date of divorce and the date the member starts to draw pension benefits at the rate of return the member achieved on his or her remaining fund.
Where the member is invested in more than one fund, then it should be assumed that the debit was invested in the same proportions. Also, should the member switch between funds, it should be assumed that the debit was similarly switched. It would also seem reasonable to ignore post-divorce ongoing contributions made by or in respect of the member when determining the return achieved.
The PSO Update does say that if it is not possible to allow for actual investment yields 'for whatever reason', then a rate of 8.5% per annum should be used. Time will tell what will be regarded as a legitimate excuse for using 8.5%.
The ex-spouse is not required to count any pension credit received against his or her IR maximum. However, where the ex-spouse is a member, in his or her own right, of an occupational scheme to which the pension credit is transferred, the pension credit must be kept separate from the other benefits to qualify for such treatment.
Pension is in payment
Pension sharing will not just affect pre-retirement pension funds. Any pension already in payment will also be taken into account as part of the divorce settlement. This raises new implications for annuity providers, as a value will have to be placed on the annuity. Similar issues will apply in defined benefit schemes which are paying pensions direct from the fund. The value will be based on the current age of the annuitant and on current long gilt yields. The regulations allow the provider to ask for evidence of the annuitant's health.
This is helpful as the value of future annuity instalments will be much less if the individual is in poor health.
Where a pension in payment is to be shared, the original annuity will have to be 'unbought', and a current value placed on it. This value will then be split between the divorcing couple.
The ex-spouse's pension share will be used to buy an annuity on his or her own life, using current annuity rates, and based on his or her sex and current age. (Alternatively, the ex-spouse may opt for drawdown, or could even be transferred into a pre-vesting arrangement depending on his or her age.) The member's share of the annuity will then be 're-bought', again on current annuity rates, allowing for his or her (older) age.
This procedure will be far from simple for the ex-spouse and the member to understand. A simple example may highlight the issues.
Mr and Mrs Smith are getting divorced. Mr Smith has a pension of £500 per month (which is level, without spouse's pension) which started five years ago on his 60th birthday. The soon-to-be ex Mrs Brown is three years younger than her husband. The pension sharing order asks that the pension is split 50%:50%.
This does not mean that each party will in future receive £250 per month. Instead a value has to be placed on the annuity, based on the member's current age, health status and ruling interest rates. This value is then split into two.
An annuity of £500 to a male aged 65 would cost £68,898 if purchased on annuity rates in force in July 2000. Mr and Mrs Brown are each to receive £34,449 worth. This will clearly buy Mr Brown £250 per month, but Mrs Brown receives only £203 per month, as being younger and female, she has a longer life expectancy. This may not be what the Browns had expected and they may wrongly conclude that someone has 'stolen' the missing £47 per month. This creates significant communications challenges for all involved.
Another challenge will arise where long gilt yields, and hence annuity rates, have changed significantly since the annuity was originally purchased. In recent years, annuities have become more expensive, so an annuity which cost £100,000 five years ago might actually be valued at a higher amount today despite
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