How are pensions split in a divorce

Dividing your assets during the process of a divorce can be one of the largest financial decisions you may need to make. Pension schemes are an asset, just like your home or the savings you might have in the bank, and will be considered as part of the overall financial settlement you and your spouse will reach.

After the breakdown of a marriage, it can be very easy for divorcing spouses to get occupied with the immediate issues, such as where they will live and what will happen to the children. This often means that pensions are forgotten, or overlooked as the issue may feel like one to worry about in the future.

What exactly is a pension?

A pension can be likened to a long term savings account that helps you put money away, which will then be a source of ongoing income for you when you retire.

Broadly, there are two main types of pensions; State pensions and private pensions.

State pensions are provided by the government, which you contribute towards through National Insurance payments. Under the present legislation, you will only receive the State pension when you reach State pension age, and you will need to have a certain number of years during which you have either paid National Insurance contributions or received certain State benefits which give you credit. The aim of the scheme is to ensure that everyone has a basic standard of living after they retire.

Private pensions can be occupational or workplace pensions set up by your employer, or privately set up by yourself. There are also different types of private pensions, the most common ones being:

• Defined Contribution Pension Schemes: The pension pot is based on how much is paid in. Money paid in by you or your employer is put into investments (such as shares) by the pension provider and the value of the pot can go up or down depending on how the investments perform. The amount you take when you retire will depend on how much you contributed, how well the investments performed, and how you decide to take the money; such as regular monthly payments or a lump sum.
• Defined benefit pension schemes: These are often set up by your employer. The amount you receive will be dependent on the provisions of the pension scheme provider, and not on how much you have paid or the performance of your investments. The pension pot is based on your salary and how long you have worked for that particular employer.

So why is it important?

The combined assets between spouses is referred to as the ‘matrimonial pot’. The overriding aim of any financial settlement in the process of a divorce is to achieve a fair outcome for both sides. As pensions are a substantive asset, there is therefore a strong chance that the settlement will not be a fair one if pensions are not considered.

As you will no longer have the benefit of the combined ‘matrimonial pot’ when you divorce, you will need to plan ahead to ensure that you have sufficient resources to live on when you retire. If you overlook the pension element of the assets, you could end up in financial difficulties after reaching retirement.

How are pensions valued?

State pensions: The government provides a forecast or valuation for your State pension. Most state pensions cannot be shared between spouses when they divorce. However, it is still really important that both spouses get valuations or forecasts of all state pension entitlements because the individual will benefit from them in the future and so they can still be taken into account when looking at who needs what, when the divorce is finalised.

Private Pensions: The valuation of a private pension will be dependent on whether the pension is in payment or not. If you are not yet receiving payments, you should start by asking your pension provider for the cash equivalent transfer value (CETV). However, in some cases, the CETV figure may not reflect the true value of the pension fund. For example, a £300,000 pension in a government funded final salary scheme may well pay out more in retirement than a £300,000 pension you have saved up in a defined benefit scheme through your private employer. Even though the balances look the same, the amount paid in retirement could differ substantially. In order to provide the Court with a clear account upon which a fair outcome can be determined, it will be necessary to obtain an accurate valuation from an expert such as a pension actuary or Pension on Divorce Expert (PODE).

How do the Courts deal with pensions within a divorce?

The Court will need to decide whether it is appropriate to share pensions to achieve an overall fair settlement within the grand scheme of all other financial resources available to the spouses. The starting point with pensions is usually to equalise each side’s income position in retirement; however this does not always mean that the available pensions will be shared out equally. For example, in a situation where one of the spouses built up a substantive pension before they got married, they may argue that it is only fair they keep that when they divorce. This is often referred to as ‘ring-fencing’. The Court may take this approach in cases where the marriage was very short with no children, or, where the case involves multiple assets of high value. Nevertheless, in most cases the Court will take into consideration all of the available assets in order to meet the needs of both parties and any children, regardless of when or how they were accumulated.

How the Court deals with the finances in a divorce depends on all the circumstances, and careful consideration must be given to the following factors:

• The income, earning capacity, property and other financial resources which each of the parties to the marriage has, or is likely to have in the foreseeable future. This includes in the case of earning capacity, any increase in that capacity which it would, in the opinion of the court, be reasonable to expect a party to the marriage to take steps to acquire;
• The financial needs, obligations and responsibilities which each of the parties to the marriage has or is likely to have in the foreseeable future;
• The standard of living enjoyed by the family before the breakdown of the marriage.
• The age of each party to the marriage and the duration of the marriage;
• Any physical or mental disability of either of the parties to the marriage;
• The contributions which each of the parties has made or is likely in the foreseeable future to make to the welfare of the family, including any contribution by looking after the home or caring for the family;
• The conduct of each of the parties, whatever the nature of the conduct and whether it occurred during the marriage or after the separation of the parties or (as the case may be), dissolution or annulment of the marriage, if that conduct is such that it would in the opinion of the court be inequitable to disregard it; and
• The value to each of the parties to the marriage of any benefit (for example, a pension) which, by reason of the divorce, that party will lose the chance of acquiring.

In cases where there are young children, the Court’s paramount concern will always be the welfare of those young children and how their needs will be met. In reality, the decisive factor in the majority of cases is the reasonable needs of the parties and the children of the family.

When it comes to pensions, there are three broad ways they can be dealt with on divorce. Which of the three ways turns out to be the best for you will depend on the type and value of the pension, the other assets and income you both have, and what your needs are. An independent financial adviser may be needed to assist and advise you as to what the best option is for your individual circumstances.

1.Pension Sharing

Pension sharing works by splitting the pension benefits at the time of the divorce. The spouse without the pension, or with she smaller pension, receives a share of the other spouses pension benefits. The spouse gaining the pension benefits gets a ‘pension credit’ and the spouse losing the benefits gets a ‘pension debit’. In some cases, the spouse receiving the pension credit will be able to choose whether to keep their pension in the existing scheme or whether to transfer it to a new pension. Pension sharing achieves what is known as a ‘clean break’. Both spouses will know at the time of divorce how much of the pension they will receive or keep. Death or remarriage of either spouse has no effect on the sharing order. Both spouses pay tax on the pension income they receive from their share of the pension at their own rate of tax.

2. Offsetting

By offsetting, the value of any pension is offset against the other assets. This means one spouse keeps their pension and in return, the other spouse would receive a greater share of the other assets. Offsetting will not be possible if there are not enough non-pension assets.

The problem with this approach is that the value of a pension fund (a right to get an income and/or capital in the future) is very hard to compare with a totally different type of asset such as the family home. So working out, if the agreement is fair, can be tricky. If you do decide to trade your right to a share of the pension pot for the family home you may think you are getting a good outcome, but in fact, the pension pot can be worth a lot more than the family home. If the pension is worth a lot more than the family home, a fair outcome might be that the person who stays in the home also gets a share of the pension, but a smaller share than 50%.

There are also tax issues that make comparing the value of the family home and the pension pot tricky. This is because a pension is mostly taxable when it is paid to you, while there is usually no tax to pay when you sell the family home.

There are problems with this approach for both you and your spouse when looking to the future. If you agree you will stay in the family home and, in exchange, agree not to make a claim on your spouses pension, you can find yourself with little or no income when you are retired unless you can build a decent pension up after the divorce. If you are the one with the larger pension and agree for your spouse to stay living in the family home, you may not have enough capital to buy a new home for you and any children.

Another issue to be aware of is that the person keeping the pension will eventually receive it as income, and will usually pay some income tax on it. On the other hand, the person staying in the home will not be taxed for owning the home.

3. Pension Attachment Orders

Another order that the Court can make is a Pension Attachment Order. Under this order, a percentage of the pension that one spouse gets, each week or month, is paid to the other spouse. A percentage of any tax-free lump sum the giving spouse receives from their pension can also be paid to the other spouse.

These orders do attract some disadvantages, such as the person receiving the benefit has to wait until the other person is receiving their pension. It is also important to understand that, with this order, pension payments end when the person who owns the pension dies or if the person receiving the pension payments re-marries. Furthermore, either person can ask the court to change the order at a later date, so they give you less certainty. Due to these issues, this type of order is very rarely made nowadays.

The complications and the Court’s approach

In July 2019, the Pension Advisory Group (PAG) produced a report that showed many legal practitioners and judges themselves were not clear on pensions and that there was much misunderstanding on how they work. Whilst 80% of financial consent orders looked at in the study had a private pension, only 14% contained a pension sharing order. Recent case law has sought to expand on the PAG findings and shed some light into how the complications should be addressed.

W v H (divorce financial remedies) [2020] EWFC B10 is an interesting case on how pensions should be treated, especially with regard to equality of income in retirement and how the practice of ring-fencing assets prior to the marriage was not always correct. The Court re-enforced that need must be the critical factor in deciding what is and is not a marital asset. In this case the husband argued that there should be equality of capital, whereas the wife argued that there should be equality of income on retirement. The Judge agreed with the wife and found that pensions should be shared to produce equal income in retirement. The Judge acknowledged that when dealing with pensions on divorce, there is no ‘one size fits all’ answer and reached the following conclusions:

• In a ‘needs case’ where the parties are nearing retirement and Defined Benefit Pension Schemes are involved, equal sharing of pension income is more likely to be appropriate than equal sharing of pension capital.
• In contrast, where Cash Equivalent Transfer Values are relatively small and the parties are relatively young, dividing pensions by reference to capital value would be more appropriate.
• It may not be appropriate to exclude pension accrued prior to the marriage in needs cases
• The Judge made specific reference to the PAG report, which states:

‘in a needs-based case, in particular where there is significant defined benefit pension involved, for the parties or court seeking to identify a fair outcome, the appropriate analysis will often be to divide the pensions separately from the other assets, based on an equalisation of incomes approach, such approach often requiring expert evidence from a PODE [pensions on divorce expert]’.

The Judge also warned against the straight-line methodology of calculation. For example, defined benefit pensions will accrue much more in value in later years when the pension holder has reached a high salary level and therefore, a straight-line methodology of apportionment may well not be fair. One of the key messages that comes out of this judgment is that pensions are intended to provide income on retirement and should be treated with that principle in mind, particularly where the parties are approaching retirement, so as not to reduce the standard of living of the less well-off party. The judgment also laid down that ring-fencing pensions accrued outside the marriage was inconsistent with the way in which non-matrimonial property is treated on divorce. In addition, in needs cases, the focus will be on the needs of the parties rather than on arguments on who contributed what.

These points were also considered in the case of KM v CV [2020] EWFC B22. In this case, the court considered the wife’s police pension under the PAG Report Guidance. The couple had entered into a long period of separation, since 2011, and the wife argued that the pension should be valued as at the date of separation, rather than the date of the trial, which was some 9 years later. This was a needs case, in which both parties were approaching retirement and as such the guidance from the PAG Report was that the fairest outcome was to base the Pension Sharing Order on equalisation of incomes on retirement, with the assistance of a Pensions on Divorce Expert (PODE), rather than simply dividing the pensions by equality of capital value. The Judge held that the relevant date for assessing the value of the pension was clearly the date of trial and not 2011. The approach taken in this case was that if the pensions are the only mechanism for meeting the needs of both parties on retirement then there will not be a ring fencing of any portion of the pension which falls outside the term of the marriage if to do so would fall short of meeting those retirement needs of both parties.

Getting the right advice and protecting your future

Given that pensions are often amongst the largest assets in a marriage, it is crucial that they are considered appropriately in the divorce settlement. It is clear that pensions can be complex and confusing. A seemingly innocent oversight now can end up costing you thousands of pounds in your retirement, at which point it will be too late to rectify the mistake. In an area as complicated as this, you should obtain independent legal advice as well as sound financial advice before you commit to any important decisions about your pension during divorce.

Article written by Esra Dogan | Family Law Solicitor | Mayfair, London

Esra, a highly experienced solicitor who has been practicing law for over 6 years. In 2016, Esra qualified as a solicitor and has since focused on the area of divorce and complex ancillary relief finance cases. With a wealth of experience in all aspects of family law, Esra is well-versed in handling divorce proceedings, financial remedy proceedings, child arrangement proceedings, and even negotiating and drafting agreements by consent outside of the court.

Esra has a particular expertise in dealing with specific issue family matters, including non-molestation and occupation applications, enforcement proceedings, variation of a financial order proceedings, and issues relating to pension sharing orders. Furthermore, Esra has extensive experience in running conduct arguments and other matters within proceedings.

If you are facing a difficult divorce or complex financial matters, Esra has the knowledge, expertise, and experience to guide you through the legal process and help you achieve a favorable outcome. Contact Esra today to schedule a consultation and discuss your specific case.

Email: esra.dogan@austinkemp.co.uk

Tel: 020 303 401 19

For further information

Salary, Pensions, Retirement and Divorce

How to Protect Your Pension in a Divorce

What is a pension sharing order?

Are divorced women losing out on sharing pension split?

Does my ex get half of my pension after divorce?