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Pensions sharing on divorce
For many people, their pension is one of the most valuable assets they have. The value of any pension assets must be taken into account in any divorce settlement or on the dissolution of any civil partnership.
Key facts
- Pension sharing orders provide a 'clean break' solution.
- There are slightly different rules for pension sharing orders in Scotland than there is in England and Wales.
- There are two ways in which an individual's ex-spouse/civil partner can receive a pension share - become a member of the pension scheme in their own right, or - transfer to another pension arrangement in their own name.
- The former spouse/civil partner of the individual will be entitled to a pension credit equal to the value of the pension debit against the member's pension rights.
- For many their pension is one of the most valuable assets they have. The value of any pension assets must be taken into account in any divorce settlement or on the dissolution of any civil partnership.
Pension sharing could apply to any divorce where proceedings started on or after 1 December 2000.
Pension sharing isn't compulsory. Like offsetting it offers a clean break solution. It's generally the preferred option for clients who have insufficient assets to offset their pension or have other assets they want to keep. The main difference between earmarking and sharing is that there is a legal transfer of ownership under pension sharing.
What pension scheme assets can be shared?
In England & Wales all pension assets belonging to the couple are taken into account on divorce.
In Scotland, only pension assets built up during the period of marriage/civil partnership are considered.
Pension sharing doesn't apply to all pension schemes. The table below gives details of what pension scheme assets can and cannot be shared:
| Pension scheme | Can be shared? |
|---|---|
| Occupational pension schemes (including AVCs) | Yes |
| Personal pension schemes | Yes |
| Stakeholder pension schemes | Yes |
| S.32 policies | Yes |
| Retirement annuity contracts | Yes |
| Statutory pension schemes | Yes |
| Free-standing AVCs | Yes |
| Employer financed retirement benefit schemes - unapproved schemes | Yes |
| Contracted-out benefits, State Second Pension (S2P), State Earnings Related Pension (SERPS) and the protected payment part of the new State Pension | Yes |
| Pensions in payment from any of the above | Yes |
| Schemes in which the only benefits are equivalent pension benefits | No |
| Basic State Pension | No |
| New State Pension | No |
| Pensions the individual is receiving as a spouse, civil partner or dependant | No |
| Pensions already subject to an earmarking or sharing order | No |
What happens after the pension sharing order takes effect?
In England and Wales pension sharing can only take place by court order. In Scotland pension sharing can be activated by court order or settlements can be reached by negotiations between the opposing solicitors; this will be contained in a 'qualifying agreement' rather than a court order.
The receiving spouse/civil partner of the individual owns the pension in their own right and can manage it as they wish. The individual's ex-spouse's/civil partner's 'share' of the pension is called a pension credit. The reduction in the individual's pension because of the pension share is called a pension debit.
The amount of pension to be transferred should be expressed as a percentage of the cash equivalent transfer value (CETV) and not as a specific lump sum (except in Scotland). This causes some practical problems, as the CETV can change quite significantly during the time that the divorce is being finalised, particularly if the stock market is going through a volatile period. The actual amount of the pension credit will not be known until the court order is finalised.
How does a pension sharing order work?
The trustees of the individual'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 individual and the individual's ex-spouse/civil partner as well as the court.
Following implementation of the order the individual's ex-spouse/civil partner will receive a pension credit which may be held within the existing pension arrangement or transferred to another pension arrangement. The individual's pension receives a corresponding pension debit.
What is the pension sharing process?
Both parties to the divorce must get valuations of their pension benefits. These are then used to agree whether a split is needed and if so, what that split will be. This information is needed before the divorce hearing. It is important the scheme/provider is made aware that the information is needed for a divorce.
It’s worth noting and making your client aware that as the split is a percentage of the value of the plan, the amount is not guaranteed. This is because the unit price of the funds will change between the original valuation to agree the split and when the benefits are actually shared after the divorce is finalised. This is not a mistake. The rules in Scotland are different as it is monetary amount that is agreed and not a percentage.
The pension sharing order may be implemented on any day, chosen by the trustees, within what’s known as the implementation period. 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. The scheme administrator chooses the valuation date within the implementation period on which to calculate the actual share of the pension rights. The benefits must then be transferred before the end of the implementation period.
Can the implementation period be extended?
In certain circumstances the trustees of an occupational pension scheme can ask 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 winding-up or where assets under a self-invested arrangement must be sold 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.
State pensions
If the individual reached State Pension age before 6 April 2016 their Additional State Pension could be shared. This is the amount paid on top of any Basic State Pension and Graduated Retirement Benefit and was based on their earnings.
If they get to State Pension age on or after 6 April 2016 and their divorce or dissolution proceedings started on or after 6 April 2016, then their protected payment can be shared. Their protected payment is the amount paid on top of the standard weekly rate of the new State Pension.
If the starting amount is more than the full new State Pension, the part of the starting amount that is above the full new State Pension is called the 'protected payment'.
To apply for a valuation of state pension DWP form BR2ONSP should be completed
What can someone do with a pension credit?
Scheme membership
Trustees of unfunded arrangements are likely to offer scheme membership to their members' ex-spouse/civil partner. The ex-spouse/civil partner must be given fair value for the pension credit, but they do not have to be given the same benefit structure as other scheme members.
External transfer
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 about the most suitable receiving vehicle must of course be given by a qualified financial adviser.
What is a disqualifying pension credit?
If the transferring plan is from 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 buy 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/civil partner chooses to retire since it has already been paid to the individual.
Some common questions
Are there any restrictions on how pension credit benefits can be taken?
Pension credit benefits can be taken as provided for under the rules of the scheme that they are part of or transferred to. There are no restrictions other than on disqualifying pension credits (see the answer above).
Do lump sums paid from pension credits count towards the lump sum allowance and the lump sum and death benefit allowance?
Yes they do, unless it is a disqualifying pension credit, these are not included as no tax-free cash can be paid from them.
Where they do count against the new allowances, is if benefits containing a disqualifying pension benefit were taken before 6 April 2024.
This is because the standard calculation for converting the amount of lifetime allowance used into the new allowances does not take into account that no tax-free cash was paid from the disqualifying pension credit. This means the allowances will be reduced by more than they should be. If this is the case, the individual should consider applying for a transition tax-free amount certificate, which will accurately reflect the tax-free benefits the individual has received.
Lump sum and lump sum and death benefit enhancement factors will be available where an individual:
- has acquired rights before 6 April 2006 under a registered pension scheme by virtue of becoming entitled to a pension credit (pre-commencement pension credit factor)
- has acquired rights under a registered pension scheme by virtue of becoming entitled to a pension credit (pension credit factor)
Can tax-free cash be taken from a pension credit?
Yes, tax-free cash can be taken from a pension credit. Tax-free cash isn't available if the benefits the pension credit came from were already in payment. This is called a disqualifying pension credit as it doesn't qualify for tax-free cash.
Disclaimer
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.