How are assets (including pensions) divided on divorce? In this blog, Family Law in Partnership Senior Associate Mariko Wilson and Professional Support Lawyer Carla Ditz take a look at how pensions are treated on divorce.
The division of assets (including pensions) on divorce will very much depend on the particular circumstances of your family. However, at the heart of any financial settlement is that ‘fairness’ ought to be achieved. There is no prescribed formula for the ultimate division of assets.
Instead, a number of factors contained in section 25 of the Matrimonial Causes Act 1975 are taken into account. These include:
- The income, earning capacity, property and other resources which each spouse has or is likely to have in the foreseeable future
- The financial needs, obligations and responsibilities which each spouse has or is likely to have in the foreseeable future
- The standard of living enjoyed during the marriage
- The ages of each of the spouses and the length of the marriage
- The financial needs of any children
The above list is not exhaustive and other factors relevant to you and your spouse’s situation may be taken into account. The starting point after a long marriage is that assets should be divided equally unless there is a good reason to depart from equality. This is what is known as the “sharing” principle. The Court will also have regard to the principle of “needs” (i.e. ensuring that both parties’ needs are met) and very occasionally, the principle of “compensation”. Crucially, the welfare of any child is paramount, meaning the court’s first consideration will be to ensure any needs of the child are met.
But what of the assets themselves? The assets in the marital pot will of course vary from liquid assets such as cash in the bank to illiquid assets like the family home. Pensions are generally one of the less liquid assets available. As with all assets and liabilities in both you and your spouse’s name, details of your pensions must be provided as part of the financial disclosure process.
A pension could be one of your or your spouse’s most valuable assets and it is crucial that an up to date valuation is obtained during the divorce or separation process. Ignoring, misinterpreting or undervaluing pension assets can be a costly mistake. Professional advice is essential.
How it all started
- It is important to note that before 1996, the courts had no power to make orders in relation to pensions on divorce. The only way to account for one spouse’s pension would be to “offset” it against another asset (discussed further below).
- It was only after the enactment of the Pensions Act 1995 that the courts were able to order pension providers to make provision for a non-member spouse in the form of an ‘earmarking order’ (now known as an ‘attachment order’.)
- This was followed by the Welfare Reform and Pensions Act 1999 which introduced ‘pension sharing orders’ for those divorces which took place after December 2000.
With these three options now available to divorcing couples, it is crucial that advice is sought as to which method is most appropriate in your particular situation.
The types of pensions
Pensions come in various guises. It is important to understand exactly what kind of pension is in question. If, for any reason, you do not have any paperwork relating to an old pension of your own, the Pension Tracing Service may be able to assist.
Pensions can typically be described as one of the following:
- The State Pension – whilst the Basic State Pension cannot be shared on divorce, the Additional State Pension is capable of being shared. From 6th April 2016, the New State Pension cannot be shared save for the ‘Protected Amount’ (see the uk website for more information)
- Private pensions
- Pensions provided by employers
Within these categories, you may have a defined benefit scheme, a defined contribution scheme, a SIPP to name but a few. The details of these separate schemes will not be covered in this blog (they warrant a blog of their own!) but it is important to note that not all pensions are created equal! Even if two pensions look equally valuable on the face of it, their underlying benefits (and so the value to you) might vary enormously.
How can pension benefits be distributed by a court on divorce?
Pension benefits can be shared/distributed in a number of ways:
- Offsetting – offsetting entails the non-member spouse receiving a share of another asset equivalent in value to the pension in lieu. This could mean one spouse receiving a larger share of the matrimonial home for example whilst the member spouse retains his/her pension.
- An attachment (formerly ‘earmarking’) order – this is where a percentage of the member’s pension (which includes any tax-free cash lump sum) is ringfenced or ‘earmarked’ for the other spouse. The effect is like deferred maintenance provision as the non-member spouse will only receive the pension benefits once the pension is in payment.
Given the nature of the attachment order, the non-member spouse is dependent on the investment (and retirement) decisions of the member spouse. The pension is also taxed in the member’s hands; the member’s tax band may well be higher than the non-member’s tax rate meaning attachment orders are often not tax efficient. Importantly, if the non-member spouse remarries, the pension annuity payments will cease. If either party dies, this will also bring the pension attachment order to an end (although, depending on the terms of the order, it may be possible to earmark a lump sum on the death of the member). For all of these reasons, attachment orders are rarely employed these days.
- A pension sharing order – if a pension sharing order is made, a percentage of the member spouse’s pension is transferred to the non-member spouse and the pension is separated into two distinct funds on divorce. In other words, the non-member spouse gets their own pension pot in their own name (which is unaffected by the remarriage or death of either spouse). This enables a clean break between spouses. The pension income generated is taxed in each recipient spouse’s hands, and so is often more tax efficient.
Get expert advice!
The world of pensions on divorce is complex. Advice from a pension expert is almost always necessary and is almost always money well spent. Establishing the future income which the pension can provide and what lump sum might be available is part of the investigative exercise. In particular, it is important to receive advice as to the best way to deal with a pension on divorce, be it by offsetting, an attachment order or pension sharing order as each mechanism has its pros and cons.
Establishing the true value of the pension scheme is vital. Even if the pension is not going to be the subject of division, its value will still be relevant in the context the overall division of assets.
What else might I need to consider?
Aside from obtaining a valuation of the pension benefits, other key questions which should be asked are:
- How long might it actually be before the member retires and the pension benefits can be accessed?
- What might retirement look like in terms of expenditure? What might you and your spouse need in retirement? Cash flow modelling can help with this.
- Do you have other resources such as savings which you could utilise on retirement?
- Are there Lifetime Allowance/other taxation issues which are relevant?
Pensions…clear as mud?
The world of pensions is by no means straightforward. An understanding on the part of the legal professionals involved as to the fundamental workings of pensions on divorce is essential. Research suggests that a lack of understanding by individuals and their legal representatives frequently results in inappropriate settlements being reached, and pension assets being unfairly distributed.
To this end, in 2017, The Pensions Advisory Group was convened with the purpose of producing a best practice guide (for judges, legal and financial practitioners as well of course as those going through a divorce themselves) to address the issues relating to pensions on divorce. The PAG is an interdisciplinary group of judges, actuaries, academics, pension advisors, family lawyers, pension lawyers and other experts including Dominic Raeside, our head of mediation at Family Law in Partnership. The best practice guide is in the process of being produced and it is intended that it will be published in June 2019.
Not giving a pension due consideration can be a costly mistake. A pension could be the most valuable asset that a party possesses and, of course, a meaningful source of income in retirement. The division of pensions on divorce is just one part of the puzzle when looking at a financial settlement. Advice should always be sought on the value and appropriate treatment of a pension in the overall financial negotiations.
For more information or advice regarding financial settlements on divorce and separation including the treatment of pensions, please contact any of our top London divorce lawyers at Family Law in Partnership on 020 7420 5000 or contact us at: firstname.lastname@example.org