This article is most relevant for those of you sitting CF4 Retirement Planning and CF5 Integrated Financial Planning, but any serious student studying for the Certificate in Financial Planning should always ensure they have a wide knowledge of all areas of financial planning. So really, it’s relevant to YOU.
40% of UK marriages end in divorce. You can therefore assume that around 40% of financial adviser’s clients will end up divorced, so the issue of pensions on divorce is a serious one that all adviser’s, support staff, administrators, paraplanners (let’s face it - everyone) must understand.
A pension is usually one of the largest assets a marriage has and so it is important that it is taken into account on divorce or on dissolution of a civil partnership (any reference to divorce in this article equally applies to civil partnerships). There is no automatic right to a spouse’s pension, but divorce courts can rule that pensions are split in one of three ways – offsetting, earmarking or pension-sharing. Pension-sharing is generally the preferred route but it is important that you understand the differences between the three options. You should also note that dividing a pension on divorce does not mean that one spouse gets a lump sum from the other spouse’s pension.
Pension-sharing
We’ll look at pension-sharing first. This is the most popular option as it provides a ‘clean break’ for the divorced couple. Pension-sharing gives one spouse a percentage of the other spouse’s pension rights (we’ll refer to this spouse as the ‘member’ as they are the member of the pension scheme being shared), and that percentage is put into the ex-spouse’s name. This means that there is an actual split of the pension with a specified amount being split from the member’s pension and being put into a separate pension in the name of the ex-spouse. As with any other pension, the ex-spouse can decide when to retire and other normal actions relating to a pension apply.
Pension sharing cannot take place without a court order, unlike other financial matters during divorce which can be settled out of court. A pension sharing order does not take effect until a Decree Absolut has been granted (the final stage of the divorce process). The pension provider will then inform the former spouse of any charges relating to the pension transfer and will make the necessary calculations to complete the pension credit. Both the member and ex-spouse will receive a notice of discharge from the pension provider which shows the pension debit and pension credit values as well as the value of the remaining fund and how charges have been settled.
So what is a pension debit and pension credit?
The ‘pension debit’ is the amount by which the value of the original member’s pension rights are reduced and the ‘pension credit’ is the corresponding amount by which the ex-spouse’s pension rights are increased.
So a pension debit is made against the member’s pension rights with a pension credit of equal value for the former spouse. A transfer is then made to another pension scheme for the former spouse, which establishes a new separate pension arrangement in the former spouse’s name. This works just as any other pension with an income and cash lump sum for the former spouse at the selected retirement age.
Here’s an example
Anne and James are getting divorced. Anne does not have a pension but James has a personal pension worth £150,000. It is agreed that the pension plan will be split 50:50, therefore the Court orders the pension provider to give Anne a Pension Credit of 50% of James’ pension. This would mean that Anne would receive £75,000 to go into a pension plan in her own name. Before this can happen, they have to wait for the Decree Absolute which comes through a number of months later. Due to a downturn in the market, James’s pension plan has dropped in value to £140,000. Therefore Anne gets 50% of the value which is £70,000.
Let’s now move onto the remaining two options.
Offsetting
Offsetting does what it says on the tin! It offsets the pension fund against other assets within the marriage. For example, the value of the pension fund may be offset against the value of the matrimonial home. So the wife may agree to not take a share of the husband’s pension, in return for a larger portion of the money in the matrimonial home. While I use the example of the wife taking a share of the husband’s pension, it can also be the other way around. However, it is more often the case that the wife has a lesser pension than the husband due to, for example, taking time off paid work to look after children. You should also bear in mind that pensions cannot be cashed in, and may be worth a lot more on retirement than when the value of it was offset against the value of other matrimonial assets.
Earmarking
Earmarking is very different. In this case, a percentage of income from the pension on retirement is awarded to the former spouse. Therefore when the member retires, the ex-spouse would start to receive the previously agreed percentage of their retirement income. Some divorcing couples do not like this option as it effectively ‘ties’ the former spouse to the member of the pension scheme (the ex-spouse) for life. You should also bear in mind that the income would stop if the pension holder died or if the ex-spouse remarried.
I hope that helps you to understand the three different options for pensions on divorce. Bear in mind that there is no reason why a divorcing couple shouldn’t decide to leave their pensions untouched and not to split or share them in any way. This is just as valid. |
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