Monday, June 15th, 2020
CEs, DBs, DCs, AVCs, MPAA and LA, GADs and GARs, SIPPs and SSASs – pensions are a minefield!
Family lawyers must grapple with pension issues in most financial remedy cases now and these issues can be seriously complicated.
The law did not always provide for pension sharing and when I first qualified as a solicitor pensions were not an asset that Judges paid much attention to. However, it gradually dawned that a pension can be one of the most valuable assets a family has. Legislation was introduced in the form of section 166 of the Pensions Act 1995, (inserted as sections 25B to 25D of the Matrimonial Causes Act 1973) which provided for pension earmarking (see more anon). Once the limitations of this were realised, matters were taken a step further by the Welfare Reform and Pensions Act 1999 that brought in pension sharing from 1 December 2000 and pension share orders have since been widely used.
Essentially, if the parties have very different pension provision that demands adjustment (considering the S25 Factors) they must consider one of the following:
1. Offsetting – one party taking more of another class of asset to even out the disparity in their pensions.
2. Pension earmarking – the party with the higher pension has their scheme earmarked to benefit the other spouse on their retirement so that the pension administrators are bound to pay a percentage sum to the recipient of the earmarking order. There are serious limitations to this: the order doesn’t take effect until the scheme member decides to retire, it doesn’t survive the death of the scheme member or the remarriage of the recipient spouse, to name just a couple. For these reasons (and because something generally better is available now) pension earmarking is very rarely used save in some exceptional circumstances.
3. Pension sharing – this allows a clean break between the parties as a debit is applied to the Scheme member’s fund and a corresponding credit is applied to the scheme of the recipient spouse after the order is obtained and implemented. This can be done by an external transfer (into a scheme that the recipient has in place or one set up to receive it) or sometimes an internal transfer to a scheme within the same company. Pension sharing means that the recipient then has much more control over their own fund and can take it when they want to, subject to the rules. A pension sharing order can only be made on a decree of divorce.
The difficulties come in comparing different types of pensions as Defined Benefit (DB) pensions (final salary schemes) are so very different in their nature to Defined Contribution (DC) schemes (money purchase schemes) – and even within these, different types of schemes can have very different features. An actuarial report will often be required to come up with fair actuarial value for DB schemes (which are often undervalued if you simply rely on the CE – the Cash Equivalent value produced by the scheme) so as to compare them more consistently to DC schemes. Also, you must consider at an early stage what are you trying to achieve – equalisation of income and, if so, at what ages or equalisation of CEs, or something different altogether? Each case will be different and depend on its own facts, but it is important to ask the right questions on appointing an actuary, so you have all the relevant information at hand to consider. A pension report should also highlight individual features of the pension schemes under scrutiny that may not otherwise be clear to anyone, as well as advise on the most efficient way overall to share.
There are particular difficulties in coming up with a fair offset value, and there are different methods of doing this – usually also requiring actuarial advice. But it must be remembered that as a result of these different methods, as well as varying assumptions and projections into the future, even actuaries will come up with different figures. There are arguments for and against all the methods. The different formulas for offsetting can produce quite different figures and actuaries will often give a summary of the results using the competing options.
Pension adjustment is simply difficult and if you are considering offsetting you should proceed with utmost caution.
And don’t forget to factor in the benefits of any state pension – whilst these cannot be shared (save any SERPs/additional state pension element) they should be taken into account, as should any other pension income that one party receives that cannot be shared, such as an overseas pension or a FAS scheme.
And another thing – tax. Don’t forget to consider tax treatment of pensions and what is payable if pensions are drawn – especially given the new freedom rules giving people so much more flexibility.
The advice of an IFA is recommended to assist in assessing a party’s individual situation.
Essential reading for anyone who wants to understand more about these issues is “A Guide to the Treatment of Pensions on Divorce by The Pension Advisory Group, July 2019” – https://www.familylaw.co.uk/docs/pdf-files/Apples_or_pears_-_Pension_offsetting_on_divorce.pdf
Liz Francis is a Partner in Hanne & Co’s Family & Divorce Law Team