Once pension assets have been identified and valued, the solicitors representing in a divorce will have to agree what is to be done with them as part of the financial settlement.
There are 3 options available:
This section looks at the properties of each and the practical reasons why each might be suitable for a particular situation.
Offsetting is the simplest method as it offers a completely clean break between the ex-spouses.
In this scenario one spouse retains the pension and the other is awarded or retains matrimonial assets which are considered to be of equal value.
Most commonly the pension is offset against the value of the marital home, these being the most valuable of all the matrimonial assets. Furthermore the matrimonial home is likely to be awarded to the spouse (usually the wife) who is bringing up any dependent children.
Because of this, and the fact that men are more likely to have a pension than women, very often the husband will keep the full value of their pension plan.
Where this doesn't work is when the pension fund is quite large and in order to keep it intact the husband would need to give up all or nearly all of the remaining matrimonial assets.
When this is the case solicitors will suggest the pension plan is divided between the two parties, see below.
An attachment order is a direction from the court which obliges the trustees of a pension scheme to pay benefits directly to an ex-spouse, rather than the member.
The order may be made against one or more of the following pension benefits:
Attachment, which was introduced as 'earmarking' under the Pensions Act 1995, can be useful in that the spouse can rely on an independent and trustworthy third party to make the payments, rather than an often reluctant ex-partner, however there are also several drawbacks which mean that it is usually the least often used option.
The main problems are:
The concept of pension sharing, then calling splitting, was first suggested by the Law Society and the Pensions Management Institute (PMI) following the judgement in Griffiths v Dawson (1993) which resulted in the requirement to take pension assets into account during a divorce.
Given that these bodies represented the two professions most likely to be practically involved in treating pension assets in divorce you might expect that the proposals would be welcomed. As it turned out the government of the day felt that earmarking was a better solution and it was not until December 2000 that sharing became a legal option.
A sharing order has the major advantage over attachment of allowing a clean break (remember this is a key objective of solicitors acting in a divorce case).
Under a sharing order the pension asset is divided into two, and one part is legally transferred to the ex-spouse. The receiving spouse now has complete control over their part of the pension and may take benefits as and when it suits them (within the legislative framework applicable to pensions generally).
There are three ways in which a sharing order may be implemented:
Note - this decision lies with the trustees and applies at scheme level, other than option 3 individual scheme members are not allowed to choose which option they want.
In practice the trustees of unfunded pension arrangements will want to avoid having to pay monetary amounts out of the scheme and will only offer scheme membership, and trustees of funded arrangements probably want to avoid looking after benefits on behalf of unconnected third parties and will only offer an external transfer.
Since December 2000 sharing has commonly been considered the most favourable option after offsetting.
The most important thing to remember is that whatever option is chosen, a fair pension valuation is still key to getting a fair overall settlement.
Financial advisers are often brought into the divorce process once a pension sharing order has been agreed, primarily because solicitors are unlikely to be qualified to advise their clients on the most suitable plan to receive their newly-acquired pensions benefits.
The trustees of the member's pension arrangement are responsible for implementing a pension sharing order, although in practice this duty will usually fall to the scheme administrator.
In order to implement a pension sharing order the administrator may require information from the trustees of the pension arrangement, the member and the ex-spouse as well as the court.
Following implementation of the order the ex-spouse will receive a pension credit which may be held within the existing pension arrangement or transferred to another pension arrangement. The member's pension receives a corresponding pension debit.
The trustees are obliged to carry out an up to date valuation as part of the implementation process. This is used when agreeing the percentage split.
The date on which this is carried out will be the Transfer Day, which will be the latest of the date of the decree absolute, 28 days after the date upon which the pension sharing order is made, and any date specified by the court on which the pension sharing order is to be effective.
A new valuation is then needed which often causes confusion because the CETV will almost certainly have changed since the initial valuation was carried out during the negotiation process. When the percentage share is calculated it will therefore be different from the amount that was expected and clients often perceive this to be a mistake.
The pension sharing order may be implemented on any day, chosen by the trustees, within the implementation period. This will be known as the Valuation Day. The implementation period runs for 4 months from the date of the pension sharing order or the date the trustees have all the information they need if later.
In certain circumstances the trustees of an occupational pension scheme can request that the implementation period be extended beyond 4 months, in order to allow them to deal with issues which affect the scheme as a whole.
The main examples of this are where a defined benefit scheme is in wind-up or where assets under a self-invested arrangement must be sold to effect the order and the trustees believe that market conditions are unsuitable to do this.
The reason for this is to ensure that none of the other scheme members are unfairly affected by the implementation of a pension share for one of their colleagues.
Trustees of unfunded arrangements are likely to offer scheme membership to their members' ex-spouses. The ex-spouse must be given fair value for the pension credit, however they do not have to be given the same benefit structure as other scheme members.
Trustees of funded occupational pension schemes are more likely to offer an external transfer. This may be paid to any approved pension arrangement, including a personal or stakeholder pension or another employer's scheme.
Any advice regarding the most suitable receiving vehicle must of course be given by a qualified financial adviser.
The pension credit from some pension arrangements must be treated in a specific way.
If the transferring plan is a pension in payment, annuity or scheme pension, it will be unwound and recalculated with the pension credit being split out as a cash equivalent value. This credit will be treated as uncrystallised and can be paid to another registered pension scheme. There is no requirement to purchase an annuity. If it is in drawdown, the split will just be applied to the drawdown fund.
The pension credit above is called a disqualifying pension credit because it will not be possible to pay out tax-free cash when the ex-spouse chooses to retire since it has already been paid to the member.
More information can be found in our article pensions sharing on divorce.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.