Technical: Financial planning around pensions and divorce
7 February 2019
Elaine Turtle, director, DP Pensions looks at the misconceptions and practicalities when dealing with pensions in a divorce case.
The early months of the year are noted in legal circles for a rise in people coming to solicitors to initiate divorce proceedings. Consequently, it is also a time financial planning firms find they see an increase in clients coming to them for financial advice around divorce.
This can be a very difficult time for people and there are many emotional and financial consequences of this decision. If they are coming to you, they have at least made the sensible decision to obtain financial advice. Many are not so lucky and just seek legal advice.
Whilst lawyers will now generally consider the impact of the pension on a divorce settlement, they invariably do not understand pensions sufficiently well to ensure the relevant rules are followed.
A good example of this would be ensuring that pension schemes see a copy of a draft sharing order ahead of receiving a final order. Often the draft order will be missing vital information such as details of the scheme receiving the ex-spouse’s pension share.
There are a number of misconceptions when it comes to the splitting of pension assets and that is why financial advice is so important. One of the misconceptions is “they can’t get their hands on my pension”. Many people believe that there is no splitting of the defined benefit (DB) pension assets from one spouse to another, but of course that isn’t true.
There are three ways the court deals with pension splitting on divorce:
1. Pension sharing
This is where the spouse is given a percentage of the former partner’s pension and it is legally treated as their money and their share is transferred to a pension in their own right. This creates a clean break between both parties.
2. Pensions offsetting
As it implies this is where the pension is offset against other assets such as the marital home to enable one party to keep it.
3. Some of the pension is paid to the former partner
This is known as pension attachment or pension earmarking with a percentage of the tax free cash going to the former spouse and/or regular payments a little like maintenance. This leaves the ex-spouse reliant on decisions made by the pension holder and does not create a clean break. These days this way is not normally used.
For those clients seeking a divorce at the moment, if it doesn’t go to court, then there is no automatic entitlement to know the spouse’s pension value, this can make it difficult to judge a fair split of the joint assets.
There are a number of considerations when a client is divorcing and where there is a financial settlement that includes one or more pensions, such as the need for independent valuations, an understanding of the scheme’s policy on sharing orders, whether the pension holder has taken any pension benefits and details such as any protections that are in place and may be lost or breached, leading to an unwanted tax bill.
Different pension scheme arrangements are dealt with in different ways:
Defined contribution pension schemes
This is one of the easier pension arrangements to deal with during a divorce as the value is based on the contributions made to date, any investment returns and the charges associated with the plan. This creates a cash equivalent transfer value (CETV) that can be used as part of the financial calculations for the divorce.
Defined benefit pension schemes
A defined benefit scheme is slightly more complicated to value as the current (or present day) value of the deferred or accrued pension is calculated by the scheme actuary.
Self invested pension schemes where a property may be involved
Self invested pensions such as a SIPP or SSAS have very flexible investment options and this can cause issues when looking at it as part of a divorce settlement. For example, a SIPP or SSAS client may be invested in commercial property and in order for the pension pot to be shared, the commercial property might need to be sold. Sometimes the commercial property may be the business premises of a company associated with one of the spouses and therefore it might be disadvantageous to force the sale and it may be that the ex spouse sets up their own SIPP and their share of the property is transferred over to their SIPP. It does still mean some contact between the parties and perhaps them agreeing when the premises might be sold or other options will need to be looked at such as offsetting.
Once the divorce and pension assets are sorted out, it is also important for clients to ensure their wills and expression of wishes forms are updated and continue to be reviewed at least annually.
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