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An actuary's view of dealing with pensions in divorce

By Geoffrey Wilson FIA

Ways of Dealing with Pensions in Matrimonial Proceedings

 Pensions need to be taken into account in a financial settlement on divorce, but there are several ways in which this can be done. The two most commonly used ways are pension sharing and offsetting. Less commonly used is pension attachment, and it is worth mentioning two other possible ways as well. Since pensions are frequently extremely complicated, there are a wide range of possibilities which may be appropriate in specific cases, on which expert advice may be needed.  

       Pension sharing

        Basic information

Pension sharing was introduced by the Welfare Reform & Pensions Act 1999 (WRAPA 1999). It was not retrospective and so is only available where the divorce or nullity proceedings were begun after 1 December 2000 . It is not available in judicial separation proceedings. It applies to the State Second Pension/SERPs but not to the basic state pension.

 Like pension attachment, Pension Sharing Orders must be made by court order. Pension sharing can be used to capitalise maintenance payments on a variation application as long as the Petition was filed on or after 1 December 2000 (MCA 1973, S31 (7B) (6a).  

       The effect of a Pension Sharing Order

A Pension Sharing Order creates pension credits and pension debits.  The beneficiary (the transferee) acquires a pension credit(s).  The person giving up part of his/her pension (the transferor) suffers a pension debit applied to his/her pension(s).

 In defined contribution schemes the pension debit consists of a reduction of a percentage of a value of the pension.  Every qualifying benefit included in the Cash Equivalent Transfer Value (CETV) must be reduced in the same proportion.  So if a Pension Sharing Order is made for 45% of a pension worth £100,000 that pension will be debited by £45,000 leaving £55,000.  The transferee receives her/his own pension credit of £45,000 which must be invested in either the same scheme or in another registered pension scheme.

 In a defined benefit scheme the position is less straightforward.  The debit takes the form of what is called a ‘negative deferred pension’ which is the amount by which the transferor’s pension will be reduced to reflect the impact of the pension debit.  The pension is calculated in the normal way but then reduced by the amount of pension given up at the time of pension sharing with the reduction increased to take account of inflation between the time of pension sharing and retirement.

       Effect of a Pension Sharing Order on the transferee

Transferees may have to leave their pension credit in the scheme from which it came (an internal transfer), may have to move the pension credit to another approved pension scheme (an external transfer) or may have the choice of doing either (see below).  

        What pensions can be shared

The following can be made the subject of Pension Sharing Orders:

·              Personal Pensions;

·              Retirement Annuity Contracts;

·              Unfunded and Funded Occupational Scheme Pensions;

·              Self Administered Schemes (SSAS);

·              The State Second Pension/SERPS;

·              Pensions in Payment;

·              Pensions subject to income drawdown;

·              AVCs and FSAVCs.

 But Pension Sharing Orders cannot be made in respect of the following:

·              The Basic State Pension;

·              Many overseas pension schemes;

·              Pensions taken into the Pension Protection Fund;

·              Excepted Public Service Schemes, i.e. former Prime Ministers, Lord Chancellors and former Speakers of the House of Commons and presumably now The House of Lords;

·              Death in Service Lump Sums;

·              Annuities;

·              Widows’ and Widowers’ and Dependant’s Pensions.

 When considering whether or not to apply for a Pension Sharing Order consider the following:

 ·              Are all the pension benefits available for sharing? In particular are some unavailable because they are already the subject of an Attachment order or excluded from sharing altogether. Has the lump sum already been taken and is therefore not available?  This last factor often applies when pension income is taken as unsecured income (income drawdown).

·              What are the transferee’s options if she obtains a pension credit? Will she be able to move her credit, have to move it or have the choice? Will this affect the age at which she can take her pension and how much will it cost?

·              Will the benefits obtained from a pension sharing order be outweighed by the loss of the opportunity to obtain an Attachment Order over, for example, death in service benefits?

·              Is the scheme under funded and will that affect the value of the pension credit?

·              Does the CETV give a fair value? If not should the percentage sought be adjusted to take account of that?

·              What about the difference in life expectancies between the couple and the effect that has on the pension each will receive?  

       Offsetting  

       Offsetting involves the transfer of other assets or cash in return for not making a claim or only a small claim against the other spouse’s pension rights. Offsetting has the virtue of being simple to effect and can be useful where pensions are small, or the priority is for one spouse to keep the family home or the parties are young. A difficult issue is in determining the value of the offset assets which is appropriate in any particular case.  

       Judicial guidance in relation to calculating offsets has not been very clear:  

·              In T v T [1998] 1FLR 1072 at page 1077 Singer J said:

‘ … it may be helpful to explain (as did Mr Ferguson, the actuary instructed on behalf of W) that there are 3 stages to arriving at this “offset” value for a spouse’s loss through divorce.  First must be determined the quantum of benefit which the loser would have enjoyed but for the ending of the marriage, next must be applied a discount to reflect present payment as compensation for future loss; and finally must be included a contingency factor to reflect the probabilities of survival and death at various points in the future both the husband and the wife.’  

·              In Maskell v Maskell [2003] 1FLR 1138 Thorpe LJ emphasised that a pension could not be compared with present capital; it was mainly subject to tax since only up to 25% could be taken as a tax free lump sum.   

·              However in Norris v Norris [2003] IFLR Bennett J distinguished Maskell and put the husband’s pension fund in at its full value.  Mr Norris was 60, whereas Mr Maskell was 41.   

·              In GW v RW [2003] 2 FLR 108 the Judge adopted the approach taken by Bennett J in Norris and refused to discount the pension to take account of tax.  

·              In Martin-Dye v Martin-Dye [2006] EWCA Civ 681 Thorpe J dealing with pensions in payment said:

       ‘Pensions in payment being different in kind to other assets should have been apportioned by means of a Pension Sharing Order … a pension in payment is no more than a whole life income – stream akin to an annuity.  It cannot be sold, commuted for cash or offered as security for borrowings.  It has no capacity for capital appreciation.  The benefit does not survive the death of the scheme member and thus cannot form part of his estate.’  

·              But in the same case Dyson LJ said of the decision in Maskell:

       “I do not read Thorpe LJ as saying that as a matter of law, it is never open to the Court to aggregate the value of pensions with other assets and distribute the resultant total value between the parties.  Examples of where this might be appropriate could be where the parties have pensions in payment which are of approximately equal value and/or where the value of the pensions is small in comparison with other assets.  It will all depend on the particular circumstances of the case.”  

       Lawyers will usually start with the pension’s CETV value. There will also be cases where way forward is to ask an IFA to calculate the cost of providing equivalent pension benefits and use that, rather than the CETV as the starting point. In either case the starting figure might be adjusted to take account of some of the following factors;  

·              At least 75% of a pension bears tax whereas lump sum payments and property adjustments do not

·              The cash/property is available now whereas the pension is not

·              The cash/property is certain whereas the pension is contingent

·              Age differences. If the spouse is much older than the scheme member the level of compensation should be reduced and vice versa

·              When was the pension built up? If it was built up prior to the period of cohabitation this may justify reducing the level of the offset

·              The other spouse’s pension.

·              See also David Burrows article at [1999] Family Law page 556 where he made an attempt at creating a formula for calculating offsets.  

       However, the unique nature of pensions means that offsetting always results in comparing apples with pears leading Judges to favour pensions sharing as in Martin-Dye.  

       Less common but possible alternatives to sharing and offsetting  

Pension Attachment

This is a court order for the scheme managers to pay part of the scheme member’s pension to the ex-spouse. It is normally less appropriate than pension sharing since it has several disadvantages. The main disadvantage is that the income for the ex-spouse is only paid during the retirement of the scheme member, so the starting point and ending point of the income are unrelated to the needs of the ex-spouse (for example, if the member is the husband, and the wife is significantly younger, then it is likely that the husband will die (and thus the pension attachment income) many years earlier than the wife. In specific cases, insurance arrangements can be set up, and agreements for example about when the member will take retirement benefits can be established, to mitigate these problems.

 Enabling the Ex-Spouse to build up a pension after divorce

In specific cases, all or part of the pension solution might be for additional maintenance to be provided so that the ex-spouse can build up some pension after divorce. Where for example a wife in her 30s has the primary responsibility for the care of the children and is only able to work part-time she may need ‘top-up’ maintenance from her former spouse. If her aim is to build up a pension of her own a combination of a lump sum or small pension sharing order with an element in the maintenance for pension contributions may be the solution. (Those with no earnings can contribute up to £3,600 a year to a pension and that those with earnings can pay up to 100% of their earnings into a pension.)

 However, if the spouse with the larger pension benefits is also likely to have higher earnings after divorce, and thus higher income tax liabilities, then it may be worth considering making a very large pension sharing order, since that spouse can re-build the pension with future contributions with larger income tax relief than the lower-earning spouse.

 Staying married!

Where a couple are older and neither wish to remarry, staying married, even though separated may offer significant pension advantages. Divorce will lose the spouse’s pension benefits in most defined benefit pension schemes, which may be a very substantial value. Staying married might be worth considering since it may protect the spouse’s pension (and may offer non-pension advantages such as tax reliefs for gifts between spouses and inheritance tax reliefs). However pension schemes rules need to checked in every case; for example in some schemes where a couple are separated for over two years the entitlement to a spouse’s pension is lost.