A Guide to the Treatment of Pensions on Divorce

Introduction

The aim of this guide is to improve understanding and encourage good practice in the area of pensions on divorce. We offer the professional assistance of a Pension on Divorce Expert (PODE), ensuring that many of the complicating features are dealt with fairly.

If any of the issues below are affecting you directly, or if you are a legal practitioner deciding whether to take the advice of a PODE, we would be delighted to help.

When a couple gets divorced, one or both parties’ pensions may be distributed between the couple.

We will now summarise the main ways of splitting pension assets: Pension Sharing Orders, Earmarking and Offsetting.

Pension Sharing Order

Qualifying or Disqualifying Credits

Almost all types of pensions can be subject to a pension sharing order, including those in payment.

After the assets have been valued and apportioned, unforeseen complexities may arise, highlighting again the importance of seeking advice. A pension credit is defined as an ex-spouse’s share; conversely, the loss created is known as a pension debit.

A pension credit will then either be qualifying or disqualifying. The best way to explain the difference between these types of credit is by example: if a credit is from uncrystallised rights (never accessed), it will be deemed ‘qualifying’, which means that the ex-spouse will be able to take a tax free cash lump sum (TFC).

However, if the credit originates from a policy that was already in payment (crystallised), they would be regarded as’ disqualifying’, meaning the spouse will not be able to take a lump, as the tax free element has previously been taken.

Importantly, a pension credit will not be tested against the ex-spouse’s annual allowance, provided the payment comes from another registered pension scheme.

Advantages and Disadvantages of Sharing Orders

Advantages of Offsetting	Disadvantages of Offsetting
Provides the couple with a clean break Provides a pension provision for both parties, including tax-free cash and income benefit Provides a pension and complete control for the ex-spouse Remarriage, death, or any other personal changes will not affect the order	The member’s future lump sum and income will be reduced It may be difficult to split some types of pensions For high earners, a pension credit could have an impact on their Lifetime Allowance The non-pension member / ex-spouse may not be able to access the pension until a date specified by the rules of the member’s pension scheme, or rules of any scheme the pension is being transferred to Implementation fees will apply

Advantages of Offsetting

Disadvantages of Offsetting

Provides the couple with a clean break
Provides a pension provision for both parties, including tax-free cash and income benefit
Provides a pension and complete control for the ex-spouse
Remarriage, death, or any other personal changes will not affect the order

The member’s future lump sum and income will be reduced
It may be difficult to split some types of pensions
For high earners, a pension credit could have an impact on their Lifetime Allowance
The non-pension member / ex-spouse may not be able to access the pension until a date specified by the rules of the member’s pension scheme, or rules of any scheme the pension is being transferred to
Implementation fees will apply

Earmarking

The member decides when the pension commences
The pension payments are taxed on the member and not the former spouse/civil partner
Payments cease on death of the member
If a former spouse remarries or enters into a new civil partnership, the order will no longer apply, and the pension will be restored to the scheme member.

Offsetting

In other circumstances, a couple may decide on an alternative arrangement, known as offsetting.

Offsetting is now the dominant practice for settling pension funds; this method concerns the future pension rights being traded for the equivalent capital or ‘money now’. It is often seen as the more attractive route, as what the ex-spouse receives could be immediately realisable, in comparison to pension funds which cannot be accessed until age 55, or a scheme’s nominated retirement age.

Although offsetting can be seen as a quick and easy method of splitting assets, it can also be complex as each party’s financial situation and liquidity of assets is not always straightforward. It can also only be used when there are significant assets to offset against.

Advantages and Disadvantages of Sharing Orders

Advantages of Sharing Orders	Disadvantages of Sharing Orders
A simple resolution that gives the couple a clean break Suitable for a couple who are both financially successful and each have pension provision in their own name One party may have greater need for the use of the other asset (ie property) If one party suffers ill health there may be a greater need for a benefit now rather than a pension later in life If the pension is small, the costs involved with a sharing order could be disproportionate to the benefit Offsetting orders are unaffected by remarriage or death	The member could be left with significantly reduced pension provision, which could be disadvantageous depending on how close they are to retiring It may not fully account for the tax situation on the respective pension accounts, as tax will be payable once in payment Mixing categories of assets could result in unfairness and valuation/liquidity issues

Advantages of Sharing Orders

Disadvantages of Sharing Orders

A simple resolution that gives the couple a clean break
Suitable for a couple who are both financially successful and each have pension provision in their own name
One party may have greater need for the use of the other asset (ie property)
If one party suffers ill health there may be a greater need for a benefit now rather than a pension later in life
If the pension is small, the costs involved with a sharing order could be disproportionate to the benefit
Offsetting orders are unaffected by remarriage or death

The member could be left with significantly reduced pension provision, which could be disadvantageous depending on how close they are to retiring
It may not fully account for the tax situation on the respective pension accounts, as tax will be payable once in payment Mixing categories of assets could result in unfairness and valuation/liquidity issues

Valuing Assets

Valuation of Defined Pension Benefits
Lifetime Allowance considerations (discussed below)
Impact on Protected Benefits
Implications of Pension Freedoms, including the potential to trigger the Money Purchase Annual Allowance
Valuation of State Benefits
Costs associated with administering the legal division of assets
Adjustments for the tax position of the couple (pre and post implementation income)
Overseas assets

The true value of a pension in the future may also be uncertain; for example, £100,000 of pension assets to commence payment in 20 years’ time may not be the same as £100,000 of capital now. A Financial Adviser could assist with financial modelling, helping an individual to assess whether taking capital upfront could potentially result in them being comparatively worse off in the medium to long term.

Every case will be unique, where retaining the family home may be worth more to an individual now, it is also important to think of future needs and ensure that sufficient retirement provision is in place. Each party should be made aware of all implications of what they are losing, retaining, and obtaining.

Other Considerations

In some circumstances this may be the first time the ex-spouse has taken on a pension or a significant sum of money to be invested. It is therefore important that before agreeing to the divorce settlement, not only take legal advice, but also financial advice is sought regarding the suitability of the investment strategy adopted.

It is essential to have a detailed understanding of the taxation rules that affect pensions, particularly in respect of the Annual Allowance, Lifetime Allowance and if either party has protections in place.

How can Tideway Help?

Financial Planning

We believe that the financial planning advice we provide is complimentary to our investment portfolio management, enabling a joined-up and comprehensive service. Your client’s needs will be assessed, including investment objectives, tax position (including Inheritance Tax planning) and risk tolerances. This allows us to focus on getting the right investment assets in place within suitable tax wrappers, in order to optimise your client’s income tax position.

To learn more about our Investment Process download our guide.

Ongoing Service

Client Feedback

The content of this document is for information purposes only and should not be construed as financial advice
It is based on options available as of July 2022; the availability of which may change in the future
Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise