Pensions and divorce
We will show how courts divide assets during a divorce, which can take into account most pension rights. We also show how offsetting, an attachment/earmarking order or a pension sharing order are applied on divorce.
- Divorce law for pensions differ between Scotland and the rest of the UK.
- Offsetting gives the ex-spouse a share of an asset equivalent to the appropriate value of the agreed share of the member’s pension – usually this involves the ex-spouse receiving a larger share of the matrimonial home.
- An attachment order (earmarking order in Scotland) is effectively deferred maintenance, giving the ex-spouse a portion of the member’s pension built up during their marriage. This approach brings various disadvantages though.
- Pension sharing separates the ex-spouse’s pension entitlement from the member’s pension, providing a clean break.
- Following the introduction and subsequent reduction of the lifetime allowance, transitional protections such as primary, enhanced, fixed and individual protections are available. These can have an impact on the decisions made during divorce.
The legislative history
When considering pensions and divorce, it’s important to look at the legislative background to understand the changes that have taken place.
Matrimonial Causes Act 1973
This Act gave courts in England and Wales the power to take the value of individual and occupational pensions into account when settling the matrimonial estate, although this wasn’t compulsory.
Matrimonial Causes (Northern Ireland) Order 1978
This order gave similar provisions to courts in Northern Ireland as those introduced in the Matrimonial Causes Act 1973 for courts in England and Wales.
Family Law (Scotland) Act 1985
In Scotland, historically the value of pension benefits could be offset as part of the financial settlement, though the ex-spouse had no direct access to the pension – there was no compulsion to allow for the pension value in sharing the assets for England, Wales or Northern Ireland. The 1985 Act set out the principles to be applied, sharing the value of matrimonial property and factors to be taken into account.
Only assets accrued during the marriage (or civil partnership) are taken into account in Scotland, whereas all assets, potentially including those earned before marriage, may be taken into account elsewhere in the UK.
Pensions Act 1995
Before the Pensions Act 1995, the only way of taking account of the value of pension benefits was by offsetting. The 1995 Act brought in earmarking orders, now known as attachment orders in England, Wales and Northern Ireland.
This Act gave courts in England, Wales, Scotland and Northern Ireland the power to earmark pensions for divorces petitioned (legally started) on or after:
- 1 July 1996 (England and Wales)
- 19 August 1996 (Scotland) or
- 10 August 1996 (Northern Ireland).
The Act also made it compulsory for courts to take pension rights into account when determining the value of the matrimonial estate.
Welfare Reform & Pensions Act 1999
This Act brought in pension sharing in divorce and nullity of marriage cases where the petition was filed with the court on or after 1 December 2000. Earmarking (now termed attachment order in England, Wales and Northern Ireland) and offsetting are available for those couples who don’t want to use pension sharing.
How are pensions valued on divorce?
This depends on where the divorce is taking place, eg in Scotland a pension is viewed in the same way as any other investment. Basically £1 in a pension is valued in the same way as £1 in an ISA. There is no factoring in of the eventual tax treatment when benefits are taken (i.e. usually only 25% of a pension is tax free, whereas an ISA is entirely tax free). Further to this, when the pension can be accessed is not factored in, so for divorces where one (or both) parties are below minimum pension age the £1 for £1 valuation may create issues.
In England, Wales and Northern Ireland pensions are not valued as any other investment, so the solicitors dealing with the divorce may need to engage the services of an actuary to determine the value of the pension rights in today's terms for the divorce.
Options for pensions
To help simplify the explanations, assume that:
- the ‘ex-spouse’ includes ‘ex-civil partner’ and
- the member is male and the ex-spouse is female.
There are differences between the law for Scotland and for the rest of the UK, and these are pointed out where relevant.
This involved getting the value (usually the cash equivalent transfer value) of the pension benefits as at the date of the divorce (or date of official separation in Scotland). This value would then be included in the total value of the matrimonial estate to be divided on divorce.
As the courts were unable to compel the pension holder to set aside any of his pension benefit for the ex-spouse, they took account of the pension’s value by offsetting it against other assets. Effectively, the ex-spouse gets another asset, or share of another asset (up to the appropriate value of the share of the member’s pension) instead of the share of the pension. Normally, this involved the ex-spouse getting a larger share of the matrimonial home to compensate for the pension share.
Example of dividing home and pension assets
A member and his spouse are divorcing. The member has a personal pension worth £150,000 and the family home is worth £200,000 (no mortgage). There are no other assets (or liabilities).
Therefore the total assets are worth £350,000. If the courts awarded each party a settlement of 50%, this would result in a value of £175,000 for each party:
- the spouse would get £175,000 of the equity in the home and
- the member would keep his pension (valued at £150,000) and get £25,000 of the equity in the home, to bring his share up to the £175,000. If he’s under age 55 and assuming no ill health or protected retirement age, he’ll not be able to access the majority of his share of the assets until he’s eligible to take pension benefits.
An attachment order (an earmarking order in Scotland), is effectively deferred maintenance. The sequence of events leading up to an earmarking / attachment order is as follows:
The court instructs the member to get a valuation of his pension benefits.
- In Scotland, this would be the cash equivalent transfer value (CETV) of the benefits as at the date of petition, or when the divorcing couple officially separated.
- Scottish courts usually take into account only benefits earned during the marriage.
- Outside Scotland, the courts will use the same CETV basis, but there may be no proportioning by the courts for the period of the marriage. This means all pension benefits, potentially including those earned before marriage, may be taken into account (except any already earmarked from an earlier divorce).
- The pension scheme provider / trustees must provide this valuation within three months of the request.
- The court issues an order to be served on the pension provider / trustees. The provider / trustees can object to the terms of an order within 14 days of its receipt. The administrator’s / trustees' normal discretion on selection of beneficiaries for death benefits may be over-ridden by an earmarking order. The order can compel the inclusion of the ex-spouse as a beneficiary for any lump sum death benefit. This power doesn’t extend to the redirection of dependants’ pensions on the member's death. The overriding of the administrator's / trustees' discretion may result in inheritance tax issues.
- If the pension benefits are subsequently transferred, the receiving scheme or provider must be given a copy of the attachment/ earmarking order by the transferring scheme. The ex-spouse should be informed of the transfer within 21 days.
What can be earmarked in England, Wales and Northern Ireland:
- A specified percentage of the pension benefits must be paid to the ex-spouse when the member starts to draw his benefits.
- The member may have to commute part of his pension for the maximum lump sum available when benefits are taken, and pay part of that lump sum to his ex-spouse.
- A specified percentage of any lump sum death benefit must be paid to the spouse in the event of the death of the member before retirement.
What can be earmarked in Scotland:
- The court can’t earmark the pension income of the member.
- Only the tax-free cash sum and lump sum death benefits can be earmarked.
Considerations when opting for attachment orders
Attachment / earmarking provides an avenue for an ex-spouse – who may have no own-right pension provision – to access the pension built up during the marriage (or in England, Wales and Northern Ireland, before the divorce). Unfortunately, the provisions bring various disadvantages:
- Attachment orders automatically lapse on remarriage of the ex-spouse, in relation to any periodical (regular) pension payments due. Any tax-free cash lump sum attached / earmarked when the member takes benefits would still be payable to the ex-spouse unless the court order specified otherwise.
- Similarly, attachment / earmarking orders automatically lapse on the member's death, except where the order covered any lump sum death benefit to be paid to the ex-spouse. In these cases, the terms of the order would still apply on the member's death, even if the pension was already in payment.
- Subject to normal HMRC rules, the member can opt to take benefits whenever he decides. This could result in delaying benefits as long as possible in the hope that the ex-spouse will remarry or die first.
- The ex-spouse has no control over the investment of the pension fund. The member could deliberately invest in poorly performing funds to diminish the value of the fund.
- Contracted-out rights can’t be earmarked, but can be used in the value for offsetting purposes.
- The pension is taxed as the member's income and attached / earmarked payments are paid after tax. For this reason, pension providers are likely to require the order to specify that the member (not the provider) is responsible for the actual payments to the ex-spouse. This may, conveniently, be arranged through a joint bank account with appropriate ongoing payments to individual accounts.
- The method of valuation for divorces outside Scotland could have serious consequences for those who marry late in their working life or for those who have been divorced more than once.
- Attaching/earmarking doesn’t allow a ‘clean break’ divorce.
The aim of pension sharing is to separate the ex-spouse's pension entitlement from the member's pension so there’s a clean break, in contrast to earmarking.
Pension sharing is available to couples divorcing throughout the UK, but isn’t compulsory.
Couples divorcing in Scotland can reach a pension share agreement by a court order or by a legally binding agreement. However, in all of England, Wales and Northern Ireland, this can only be achieved by a court order.
The pension sharing process
- The court instructs the member to get a valuation of his pension benefits CETV, along with certain other information about his benefits. If a CETV has been provided in the last 12 months, that figure can be used.
- If an up-to-date valuation is needed, the provider or trustees of the pension scheme must provide the valuation within three months (or no later than six weeks before the divorce hearing if the provider / trustees had prior notice of the impending hearing). If there’s no request for a CETV, the scheme must provide the requested information within one month. It’s important that the information request makes it clear that this is needed as part of the divorce process, so the scheme knows that these deadlines apply.
- The court will decide how much of the pension rights should be allocated to the ex-spouse, and the member’s pension rights will be reduced by a corresponding amount. This reduction is known as a pension debit.
- In Scotland, the order may instruct a monetary amount or a percentage of the pension benefit to be subject to a debit. Outside Scotland, the debit amount must be a percentage. This is particularly important given that the value of the pensions may have changed substantially from the point of separation to the point the pension debit is actioned.
- Contracted-out rights may be split.
- The rights allocated to the ex-spouse are known as a pension credit if paid from uncrystallised funds. It’s a disqualifying pension credit if this is paid from crystallised funds.
- The existing pension scheme can choose to allow the ex-spouse to join the scheme in her own right, or to take the transfer value to another registered pension scheme. In practice, it’s likely most schemes will only allow a transfer out. There are two exception categories:
where the member’s pension is being paid through a guaranteed pension annuity with a pension provider, the pension provider may insist on an annuity with that provider (remember the ex-spouse needs to meet the minimum pension age rules), and
where assets can’t be readily cashed in, the scheme may decide the ex-spouse needs to become a member of the scheme in her own name. This would apply in, for example, unfunded schemes, public sector schemes or, where the assets are in property such as in SIPPs / SSASs).
- The scheme can choose a default option where the ex-spouse is unable, or unwilling, to make a decision on where to transfer her pension share.
- Pension schemes are allowed to pass on the costs of implementing pension sharing orders to divorcing couples. The regulations don’t specify limits on the charges, but if the scheme requires charges to be paid, the scheme must notify the couple of the charges before the order / agreement is made.
Once the pension sharing order is granted
When the pension provider / trustees get a pension sharing order:
- they have three weeks from receipt to appeal against any order / agreement
- they can delay the start of the implementation period until charges are paid or while relevant information is outstanding (or while an appeal is being decided)
- they have four months to implement the pension sharing order. This implementation period involves discharging the pension debit / credit by way of an internal or external transfer.
Interaction with the lifetime allowance (LTA)
Where offsetting applies, legislation has no direct impact, as these financial arrangements work outside the pension scheme.
Attachment / earmarking orders
The total benefits, pension and tax-free cash, including payments to be made through the order to the ex-spouse, are assessable against the member’s lifetime allowance (LTA) and for the member’s income tax liability. This is despite the fact that a portion of the benefits will be paid to the ex-spouse.
The pension remains the income of the scheme member and:
- he is chargeable to income tax on the whole amount and
- no deduction is available for the amount paid under the attachment order.
The pension received by the scheme member’s ex-spouse or ex-partner is tax-free in her hands. An attachment order may also be referred to as an earmarking order.
The taxation of pension income: Pension paid to former spouse or civil partner EIM74010
This can be broadly split into effects on the member and effects on the ex-spouse. Pension sharing also has an impact on existing Lifetime allowance protections which are covered in the protection articles.
Effects on the member
- The value of any pension debit from uncrystallised funds will not count against the member's LTA, and
- if the member has registered for primary protection and pension sharing arrangements have been agreed after 5 April 2006, the protected LTA will be reduced (and may be lost).
- If the member has individual protection 2014 or 2016 (IP14 or IP16) the relevant amount used for the protected value is reduced by the amount of any pension debit. If the transfer day is on or after 6 April 2015 (for IP14) or on or after 6 April 2017 (for IP16), the pension debit amount is first reduced by 5% for each complete tax year between 5 April 2014 / 5 April 2016 and the transfer day. This could result in IP14 / IP16 being reduced or lost in full.
Finance Act 2014 Schedule 6 part 1
Effects on the ex-spouse
- A pension credit will not be treated as a contribution when checking against the annual allowance.
- The value of any pension credits received after A-Day will count against the LTA even if the source of the credit is a pension already in payment
- If a disqualifying pension credit is received and the entitlement to the pension it came from arose after 5 April 2006 (known as a post commencement pension in payment) the ex-spouse can register the pension credit for an additional LTA, as this will already have counted against the member's LTA. This registration must be completed within five years after 31 January following the tax year when the pension sharing order was made.
- Once the ex-spouse has received the pension credit, he / she has control over the investment and timing of when benefits are taken (that is, subject to the normal rules).
- Pensions in payment which originated from a pension credit are taxed as the individual’s own income (the ex-spouse pays the tax on the part she has been given).
Transitional protection and divorce
A number of transitional protections have been made available with the introduction and subsequent reduction of the lifetime allowance. These can have an impact on the decisions made during divorce.
Frequently asked questions on pensions and divorce
What happens once a pension sharing order is finalised?
To enable a provider to take action for the pension sharing, they need certain information from the ex-spouse and copy documentation for the divorce.
In broad terms details required are:
- For the ex-spouse: full name (and details of all previous names used by that person), date of birth and National Insurance number and contact details.
- A copy of the final pension sharing order (stamped by the court).
- A copy of the divorce papers, including decree absolute. In Scotland, there’s a one-stage divorce decree, called a decree of divorce (or decree nisi). It’s also possible to finalise pension sharing in Scotland by the completion of the minute of agreement.
- Confirmation there’s no appeal pending on the pension sharing order. The provider has four months from the time they receive all the necessary documentation (known as the implementation period) to implement the terms of the pension sharing order.
Once the provider has all the documentation and information required, it will arrange for the pension debit to be released. Following payment of the pension debit, the member and ex-spouse will normally receive a discharge notice confirming the amounts involved and the valuation date for the CETV.
How is the value of the pension credit calculated?
The pension credit share is based on a valuation CETV of the member's policy or scheme benefits. Once the pension share is agreed by the court, this is applied to an updated CETV to obtain the value of the pension credit. The eventual CETV may be more or less than the original CETV valuation. In Scotland the share can be a monetary amount, and if this is the case the increase / decrease in CETV will be academic (although any monetary amount will be limited to 100% of the CETV if this is lower).
The legislation allows the pension arrangement's administrator to decide the valuation day for actual implementation of the pension share within the implementation period.
Any benefit earned or contributions paid after the date of the court order should be excluded from the valuation.
What are the ex-spouse’s pension credit options?
To help ensure a clean break the ex-spouse will probably:
- transfer their pension credit to a personal or stakeholder pension in their own name
- transfer their pension credit to a pension scheme of which the ex-spouse is already a member, but only if the scheme rules allow
- transfer their pension credit to a buyout policy (from occupational scheme only).
Can the ex-spouse join the same occupational scheme as the client?
This may be possible and depends on whether the scheme rules allow pension credit members.
What if the ex-spouse doesn’t make a decision about their pension credit?
This depends on the member's scheme. In some circumstances it may be possible to transfer the benefits out to a buyout policy or some other default option.
If the scheme rules don’t include a default option, it may be the pension sharing transaction is simply in limbo until the ex-spouse complies with the information request. If this situation persists, the member may have to go back to the Court to vary the order.
How do the April 2015 pension freedoms rules affect divorce?
Pension flexibility, introduced in April 2015, raises further issues around how pensions are considered on divorce and this affects all three options (offsetting, earmarking and pension splitting). Although pension legislation has been changed, other relevant parts of legislation (and practice) in relation to divorce have not. It’s too soon for any case law covering interaction between the new pension flexibility and divorce, but legal challenge could come. In the meantime there should be even more focus on making sure court orders reflect the intended result, in a way that can’t be frustrated through pensions flexibility. Additional issues include:
Currently pensions aren’t usually valued on a pound for pound basis with other assets, due to the lack of access to the full value. However, for those “silver divorcees” who are over 55, there’s now total access to defined contribution pension funds. This may lead to value parity with other assets. If so, the tax and future contribution issues surrounding flexible access need to be addressed in the settlement.
- Attachment/ Earmarking
Pension flexibility may have a significant impact on the application of attachment/ earmarking orders - potentially leaving scope to circumvent the requirements set out in the order, unless the details in the order are very specific.
For example, the pension-owning spouse may be able to avoid the payment of the income as set out in the earmarking order. This could be done by choosing to take all benefits as an uncrystallised funds pension lump sum (UFPLS). If the earmarking order doesn't specify exactly when and how benefits must be taken, and / or doesn't specify "tax-free lump" or "PCLS", the order can be circumvented by taking the UFPLS (which doesn't pay a PCLS). Then, if there are no pension funds left to crystallise, there’s no income left to be covered by an income earmarking order.
Also (although not strictly an issue created by pensions flexibility) historically, the assumption was probably that pension income to be earmarked would be annuity income. Now though, the member could go into drawdown and take no drawdown income or a minimal amount of drawdown. In addition, legislation, since 2015, allows annuity income to reduce (meaning the original intention behind an earmarking order could be frustrated).
However, many pension providers will not give access to these options if they believe doing so could prevent them from fulfilling the requirements of the attachment/ earmarking order.
In April 2016, the FCA published PS16/12 stating “it is for the courts to vary any attachment order that may not work as intended should the member take advantage of the pension freedoms to access the pension benefits.” We expect a pension provider would ask that the Order is varied before they’d agree to put benefits in to payment.
- Pension sharing
Since April 2015, the non-pension owning spouse may prefer to have cash rather than a share of a pension fund and therefore although pension sharing might have previously taken place, it might not now. Where the member is over 55 this is possible, even if the spouse is much younger, as the right to access the pension fund is linked to the age of the pension policyholder.
The courts may decide that an UFPLS, or a series of UFPLS, should be paid instead of pension sharing. However, that could result in serious tax implications for the member and restrict tax relief on future contributions (because of the money purchase annual allowance).
All these conditions call for detailed financial advice and could lead to legal challenges, further expense, delay and frustration for many.
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