Pensions on divorce

What are the options for dealing with pensions on divorce?

Once pension assets have been identified and valued, together with their solicitors, the divorcing couple will have to agree what is to be done with them as part of the financial settlement.

What can be done with the pension assets on divorce?

There are 3 options available:

• Offsetting the pension against other matrimonial assets.
• A pension attachment order (formerly known as earmarking).
• A pension sharing order.

We'll look at the properties of each and the practical reasons why each might be suitable for a particular situation.

Offsetting

Offsetting is the simplest method as it offers a completely clean break between the ex-spouses/civil partners.

In this scenario one spouse/civil partner retains the pension and the other retains other matrimonial assets.

Most commonly the pension is offset against the value of the marital home; these usually being the most valuable of all the matrimonial assets. Furthermore, the matrimonial home is likely to be awarded to the spouse/civil partner who is bringing up any dependent children.

This doesn't work if the pension fund is quite large. To keep it intact, the spouse/civil partner without the children would need to give up all, or nearly all, of the remaining matrimonial assets. When this is the case, solicitors may suggest the pension plan is divided between the two parties; see the following sections on attachment orders and pension sharing.

Attachment order (earmarking)

An attachment order is an instruction from the court which requires the trustees of a pension scheme to pay benefits directly to an ex-spouse/civil partner, rather than the member.

The order may be made against one or more of the following pension benefits:

• The tax-free cash or PCLS.
• The member's pension.
• The spouse/civil partner's death-in-service lump sum.

Attachment, which was introduced as 'earmarking' under the Pensions Act 1995, can be useful in that the spouse/civil partner can rely on an independent and trustworthy third party to make the payments, rather than an often-reluctant ex. There are also several drawbacks which mean that it is usually the least used option.

The main problems are:

• The order only comes into effect when benefits are taken. As this is the member's decision it can be delayed to suit them (even if they are just being difficult).
• Similarly the member can choose the format of benefits; if the order applies to the tax free cash, the member can choose not to take it (unless specifically directed otherwise in the order).
• The order prevents a clean financial break. Since the ex- spouse/civil partner must keep in touch, at least with the scheme trustees, in order to benefit.
• Any pension benefits will be taxed as belonging to the member. This is particularly onerous if the member is a higher rate taxpayer, and the ex-spouse/civil partner isn't.
• The order may lapse in the event of the member's death or on the remarriage of the ex-spouse/civil partner (this can be specifically dealt with by attaching the death in service benefit and using careful wording in the order to exclude cessation on remarriage but often it is not).
• Earmarking orders are notoriously complicated to draft with many being unworkable.

Sharing

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/civil partner. The receiving spouse/civil partner now has complete control over their part of the pension and may take benefits as and when it suits them (within the pension regulations that applies at the time).

There are three ways in which a sharing order may be implemented:

1. The ex-spouse/civil partner may be offered membership of the pension scheme.
2. The ex-spouse/civil partner may be offered a transfer to their own pension plan.
3. The trustees may choose to offer both options.

Note - this decision lies with the trustees and applies at scheme level; 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 usually only offer scheme membership. In contrast trustees of funded arrangements probably want to avoid looking after benefits on behalf of unconnected third parties and will usually 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.