Outside of the family home, pensions are often the biggest asset to share when two people divorce. Despite this, however, pension assets are frequently ignored or simply overlooked, especially in the early part of divorce proceedings, resulting in rushed and potentially unsatisfactory outcomes.
Why is this?
For many clients, it can be a case of “out of sight, out of mind”. Unless one or both parties are nearing retirement age, they may be overly focused on how they will survive now, not in their seemingly far-off future.
Equally, for professional advisers, the perceived complexity of different pension types and the options available on divorce can make it tempting to resort to the easiest solution by default.
It’s true: pensions can be complicated. But the best divorce solicitors know that a little bit of understanding and expert advice can go a long way to securing better client outcomes with fewer delays.
Here’s what you need to know.
What are the options for pensions on divorce?
1. Offsetting
With offsetting, each party keeps their existing pensions and other assets are used to offset any disparity. For example, one person keeps the larger pension while the other person keeps the house or car.
Pros:
- Simplicity – avoiding the need to share a potentially complex pension asset
- Offers a “clean break” scenario between parties
- Suited to cases where pension assets are small and both parties are young
Cons:
- May still require complex calculations to value the pension rights
- Often not possible where pension assets are considerable
Offsetting is a relatively simple solution, which makes it an appealing, go-to option for some divorce solicitors.
2. Attachment
Attachment gives rights to the person who doesn’t hold the pension to receive income or capital from the pension in the future. Rather than being owned from completion of divorce, the benefits are earmarked for the future – usually receivable once the pension holder retires.
Pros:
- None to speak of – other than that the pension is at least considered!
Cons:
- Pension holder (i.e. ex-spouse) controls when the benefits commence as well as investment decisions prior to retirement (a position that’s potentially open to abuse)
- Non-pension holders that re-marry may lose rights to the future pension
- Death can affect the rights to the benefits
- Tax is levied entirely on the pension holder, which can be detrimental to the other party
- Doesn’t offer a “clean break” scenario between parties
The risks and uncertainty with attachment, particularly for the non-pension holder, make it an archaic solution that’s rarely used.
3. Sharing
With sharing, pension assets are split at the point of divorce. The person who receives the pension share (pension credit) has the assets transferred into their own name from their ex-spouse’s rights (pension debit). While it’s sometimes possible to maintain the pension credit in the existing pension scheme (under the new member’s name), often it must be transferred into a new plan.
Pros:
- Makes it possible to equalise incomes at retirement
- New pension member controls their own investment and retirement decisions
- Benefits aren’t affected by death or re-marriage
- Tax is paid by the owner of the new plan, often resulting in a lower overall tax
- Offers a “clean break” scenario between parties
Cons:
- Involves complexity around valuing current pension rights and how these translate into a future income stream
- May require an actuary to calculate an equalised income at retirement, which involves additional time and cost
Sharing is a good solution where there are significant pension assets, especially where there is a disparity between parties.
How are different pension rights valued and treated?
State Pensions
State Pensions are an unfunded promise to pay a future income stream. It’s usually not possible share the State Pension. Where State Pensions are the main source of future retirement income, offsetting is often used.
Defined contribution (DC) pensions
These are “pots” of money built up during working life based on how much is paid in and growth of the underlying assets. It’s relatively straightforward to share these assets because the value is known. However, the income they could produce at retirement must be accounted for and they can be more complex where couples are significantly different in age.
Defined Benefit (DB)
This is the “promise” of a future pension at retirement, usually provided by an employer and largely based on length of service and salary with the company. Providing a current-day cash equivalent transfer value is complex, as is interpreting what income that may provide for a new member in the future. Often, sharing these schemes result in the pension debit member retaining a DB benefit and the pension credit member obtaining a DC pension.
How can Chartered Financial Advisers (CFAs) help?
When it comes to pensions, we have years of experience in helping divorce solicitors achieve great outcomes for their clients. We help deal with all the complexity so you and your client don’t have to, and tie all the elements together so you can focus on what you do best.
Offer your client the most appropriate solution
Your pensions expertise doesn’t have to end with offsetting. In many divorce proceedings, pension sharing is the right course of action. We can offer information and expert advice on all aspects of pensions, so that you can offer your client the best possible solution for their situation.
Avoid unnecessary delays
Unfortunately, pensions can be an afterthought. Actuarial analysis often takes longer than they expect, which delays the divorce process. But this doesn’t have to be the case. By engaging with other professionals early in the process, we can help you progress quickly and stay on track.
Get better value from actuarial reports
Actuaries play an important role in calculating equalised incomes at retirement. However, we too often see actuarial reports that are a waste of client money because they should have been done better. This isn’t usually down to a poor actuary but a poor brief – because it’s hard for clients to know what to ask for. We can help here and make sure that clients get what they really need from actuarial reports.
Strengthen your negotiating position
As you know, in the negotiation room, knowledge is power. We can provide robust financial forecasts for your client, so that you can enter negotiations accurately understanding their earning potential and how much income they’ll need both before and during retirement. This gives you a powerful tool for negotiation with the other party and a solid rationale for your chosen position.
Secure your client a better outcome
Unlike the comparatively blunt approach of offsetting, or the risky loss of control with attachment, pension sharing offers a path to a truly equitable income in retirement. Especially for the less well-off party in a divorce, it’s more likely to lead to what feels like a fair and satisfactory resolution. We can offer everything you need to secure this outcome.
Talk to us
To wrap up, our key takeaway is this: don’t leave the pensions until the last minute. It pays to talk to your clients about pensions early and help them to choose the best solution for their situation.
In most cases where pensions are a significant proportion of joint assets, pension sharing is the best course of action. Calculating transfer values and interpreting the results is a complex business, but we can help ease the burden. The earlier we can get involved, the more value we can add for you and your clients.
Get in touch and we can explore the possibilities together.
Author: Phil Hasell, Director and Chartered Financial Planner.
