Pensions and Divorce.
Pensions have become one of the most technical and difficult areas in family law and divorce. This introduction aims to help you understand some of the basic concepts, so that you can approach the topic in an informed way. But you need to get advice from an experienced divorce lawyer who specialises in pensions about your own situation – otherwise you can make mistakes which will cost you dearly, some of which may only come to light years later.
I have made a personal mission to understand this area of law so that I can advise my clients clearly and accurately, and for many years I have focused on this subject and stayed up to date with changes. I was amongst the first solicitors in the country to be accredited by Resolution as an expert in this topic. It is surprisingly complicated and I am still learning all the time.
Some of my clients tell me that they are not worried about pensions. I understand why they say that, particularly if they are coping with other changes in their life, and have more immediate concerns. But I try gently to persuade them to think differently, because one day all of us will want to stop working and need a replacement income. Sorting out the best pension arrangements you can, in the context of a divorce, is an important aspect of the overall picture, and you need expert advice and guidance.
You and I will need to review your pension arrangements and those of your husband/ wife. In all likelihood we will need to obtain a specialist report from an actuary, who will examine the pension arrangements, and explain the options which might be available to you, and what the effect of those would be. Obtaining that report is a technical exercise, because you need to find the right actuary, you need to provide all the information the actuary will need and, you need to ask him/her the right questions, otherwise your money may be wasted. You will make your decisions based on unreliable information, which could have serious consequences for you. Help and guidance from a specialist solicitor who understands the subject is essential.
In some cases we will need to get written advice from an IFA (‘Independent Financial Adviser’) as well as - or instead of - from an actuary. IFAs can be very knowledgeable and a handful of them really understand the subject of pensions in detail, and can give accurate and helpful advice. Often they will point out hidden snags or make suggestions which will help you to maximise your income in retirement. You will need help to identify whether you need to get a report from an IFA, and to ensure that the right questions are asked.
You will also need help and guidance from a specialist solicitor properly to understand the reports produced by the actuary and IFA. Actuaries and IFAs are intelligent and articulate people, but their reports are often quite detailed, and most people find they need to talk them through with a solicitor who has seen dozens of these reports before, to ensure they understand them correctly.
Between a solicitor who specialises in pensions on divorce, an actuary and a specialist IFA, you can end up spending quite a lot of money on advice. You should see that expenditure as an investment, because mistakes and misunderstandings now can cause you real hardship in the future.
How do courts treat pensions in divorce?
In the early days of my career it was often difficult to persuade judges to look carefully at pensions in a divorce. Over the years they have moved on, and now they will want to make sure that pensions are properly addressed in almost every case, except possibly where the husband and wife are both quite young, and have only been married for a short period of time.
In comparatively wealthy families, pensions are often treated very much like other investments and savings, partly because those assets and savings are expected to generate an income in the future much like the pension, so the pensions and other assets will be shared out as part of the same exercise. But for most families the pension has to be treated quite differently and separately from other savings and assets.
A judge will try to adjust your pension arrangements using, primarily, pension sharing orders of which I say a little more below. But judges are not experts on pensions, so they rely on the information given to them by the parties’ solicitors, including the reports the parties’ solicitors obtain from an actuary. It is really for you and your solicitor to explain the possible adjustments the judge might make, and what the effect would be, and why the particular outcome you propose should be chosen rather than the outcome preferred by your former husband/wife. It is a very difficult area and the difference between a favourable outcome and an unfavourable outcome can be very significant in the long term.
In broad terms, the judge will adjust the pension you and your husband/wife have accrued to date, rather than any pension you or s/he will accrue in years to come. The judge may be persuaded that the pensions should simply be shared proportionately according to their cash equivalent values, or s/he may wish to try to ensure that the benefits available in retirement are shared fairly. A few percentage points can make a big difference over the long term.
There have been cases where intelligent and thoughtful judges have made pension sharing orders without fully understanding the consequences, because they were not given reliable information on which to base their decision.
What is pension offsetting?
Some of my clients would prefer to pay their former husband/wife an immediate lump sum of money, or give him/her a bigger share of the equity in their house, to retain his/her pension intact. This is known as offsetting, and it raises important questions, because it is very difficult to determine the correct sum to offset against a particular amount of pension. If you are interested in an offsetting arrangement you need advice from a solicitor who specialises in pensions in divorce, because the sums of money involved can be very large indeed. Although there is no correct answer there are certainly many incorrect answers, and mistakes are very expensive.
Pensions and divorce – a historical context.
The law about pensions in divorce has developed and changed significantly over the 25 or so years I have been in practice.
When I first became a family law specialist solicitor, people were only beginning to see the significance of pensions in the context of divorce. I remember, in the early days, advising a woman who had been married to a senior civil servant. They were approaching retirement age, and their most important assets were their house, and the pension he had accrued during his career. The pension was at least as important to them as the house because they both intended to live on it in future years. But there was very little they could do to make sure that both of them could live in reasonable comfort for the rest of their lives. Her husband suggested that she should have the whole of the house on the basis that he would keep his pension, but that would not have given her anything to live on in the coming years. In the event the judge directed that they should sell the house and buy two smaller properties and that her husband should share his pension by giving her maintenance. That was the best available solution at the time but it was problematic because if he died before her the pension would stop, leaving her with nothing to live on.
The law evolved over the years to begin to tackle those issues. The changes involved consultation and cooperation with the pensions industry which really had little to gain from any change. Certainly, pension schemes did not wish to become involved in paying extra pensions to the former husbands and wives of pensioners on their books.
The first step was the introduction of pension attachment orders. These are essentially court orders directed to the pension fund requiring them to pay a specified percentage of the employee’s pension to his/her former husband or wife, rather than to the pensioner. Pension attachment orders represent a partial solution to some of the problems, but leave many issues unresolved. In particular as soon as the pensioner dies the pension income ceases, so the former husband or wife receives nothing from that point onwards. Also, if the former husband or wife remarries his/her income ceases immediately, whereas the pensioner is free to remarry without affecting his/her income. Pension attachment orders are still available as an option, but they are now very little used.
The second step was the introduction of pension sharing orders which was a much more fundamental and important change. It is a complicated subject, but in essence a pension sharing order transfers part of the pension scheme from one party to the other. How it works in practice varies from scheme to scheme, but the simplest example might be where the pension consists in money held in a personal pension scheme in the husband’s name. In that instance a pension sharing order transfers part of that money into a separate pension scheme held in the name of the wife. So she has her own pension scheme, which she can draw from when she reaches her retirement years, quite independently of her former husband.
That example explains the basic principle of a pension sharing order quite simply. But pension sharing orders can become much more complicated depending on the type of pension in question, and small errors or misunderstandings can have serious long-term consequences.
Different kinds of pensions.
Every pension scheme is unique; each has its own rules and terms and conditions, and there is no substitute for understanding the detail of the particular scheme you are looking at. But most pension schemes can be put into one of a relatively small number of categories.
Defined benefit and defined contribution pension schemes.
This is an important distinction to grasp. In some pension schemes the amount of money you will receive in retirement, depends on two factors - the salary you earned when you were working, and the number of years of service you accrued. This applies, for example, in the NHS pension scheme, and many others. These schemes are known as defined benefit schemes.
Most defined benefit schemes are to be found in the public sector, where they are funded by the government. Historically defined benefit schemes were also quite common in the private sector but they caused problems, because the people administering the scheme (the pension trustees) never knew quite how much money they would have to pay out to their pensioners. People lived longer than was previously predicted, and returns on the assets which the trustees had invested in to fund the pensions were less than was anticipated. So there were cases where defined benefit schemes ran into difficulties because they did not have enough money to pay the pensions they are committed to. As those problems emerged many defined benefit schemes, particularly in the private sector, began to close down, or to change progressively to defined contribution pension schemes.
A defined contribution scheme is in many ways simpler, than a defined benefit scheme. In a defined contribution scheme the employee makes contributions each month from his or her salary into a savings scheme. Generally the employer also makes a contribution, and to encourage us all to make contributions, the government treats contributions into the scheme favourably when it comes to tax. When the employee reaches retirement the amount of pension s/he receives depends on how much has been saved into the scheme; the salary s/he was earning is not directly relevant.
Defined contribution schemes are much easier to administer. So most pensions, other than those funded by the government, have moved in the direction of becoming defined contribution schemes.
Funded and unfunded pension schemes.
All defined benefit pension schemes fall into one of these two categories. As I have explained above, a defined benefit scheme is one in which the money the employee receives in retirement is calculated according to the salary s/he received when s/he was working, and the number of years service accrued.
Funded pension schemes are generally to be found amongst large-scale employers. The important point is that the people who administer the scheme (the trustees) hold investments out of which the pension is to be paid. Most unfunded pension schemes are in the public sector – for example the Teachers Pension Scheme and the Armed Forces Pension Scheme. The important point here is that the people who administer the scheme do not hold investments out of which they pay the pensions, instead the government or employer is committed to pay those pensions out of tax income or future earnings it receives in the future.
This difference becomes relevant when you look at the pensions in divorce, because the options available to the employee’s former husband or wife are different.
The State Pension Scheme.
The state pension scheme has never been particularly generous, but it forms part of most people’s retirement planning, and so it needs consideration.
The state pension scheme is quite complicated. The government introduced a revised scheme called the New State Pension in 2016 which (amongst other things) was intended to simplify the state pension. In the longer term it probably will, but in the short term it can make it more complicated for many people.
You can obtain a personalised projection of your New State Pension from the government website. Essentially your entitlement depends on the number of years National Insurance Contributions you have made, plus potentially what is called a Protected Payment which recognises any extra contributions you have made to earlier versions of the state pension, of which SERPS is probably the best known.
Often women have made fewer National Insurance Contributions during the course of their careers than men, because they may have taken years out to look after the family etc, so a husband and wife who are separating can have very different entitlements to the New State Pension. Most people agree that this needs to be taken into account in the overall settlement, but it can be quite tricky in practice because the court can’t make a pension sharing order against the New State Pension, with the limited exception of the Protected Payment. So we have to look at other options.
Self invested pension schemes (SIPs)
Essentially a SIP is a pension arrangement tailored to the individual. Each SIP is different, and requires special attention. The terms of the scheme will be set out in a document which is unique to it, although there are often similarities.
Typically, where a business owner wishes to acquire premises from which the business operates, s/he is advised to acquire them as part of a SIP, which then rents the premises to the business. This can be an effective strategy for tax purposes. So the assets of a SIP will often include business properties, but they can include other kinds of assets. To understand the scheme, the assets in it often need to be reviewed and possibly revalued.
A pension sharing order can be made against a SIP, but raising cash within the SIP to implement the order may be a challenge, leaving the recipient of the order with few options.
If you, or your former husband or wife, have a SIP you will need to take individual advice from a solicitor who specialises on pensions in the context of divorce.
The Pension Protection Scheme
This scheme affects a relatively small but growing number of people, but it is important to be aware of it. Essentially the scheme was set up several years ago to administer the pension schemes of employers which go into liquidation. Generally speaking the employees have to accept a lower level of pension than they were originally promised, but the reduced pension is paid by way of a levy on other pension schemes.
Many pension schemes in the Pension Protection Scheme will relate to the early days of your career, when you were earning pension entitlement which you may almost have forgotten.
But they do need special consideration because the options available to the employee’s former husband or wife are very limited. Generally pension provision in the Pension Protection Scheme can only be subject to a compensation sharing order, so the issue has to be tackled in a different way
What is meant by Cash Equivalent (‘C.E.’) value?
You will hear this term often if you become involved in a discussion about pensions in the context of divorce. It is an indication of the value of the pension, but it needs to be treated with caution and its limitations must be understood.
The cash equivalent value (‘C.E.’) is a figure used in the pensions industry for other purposes, it was not specifically designed for use in divorce. Essentially, it was designed for the situation where an employee transfers his/her pension entitlement from pension scheme A to pension scheme B. If that happens the people administering pension scheme B will have to accept responsibility to pay the pension so, naturally, they will want some money from scheme A to do that. The cash equivalent value is the figure scheme A produces using its own scheme actuary and its own formulae.
As a member of a pension scheme (except the New State Pension scheme, pensions in payment and pensions in the Pension Protection Fund) you are entitled to request a cash equivalent value from the scheme free of charge. You will be asked to do this, but it is important to be guided by your solicitor, because in most cases you are only entitled to request a free valuation once a year, after which you have to pay.
It is relatively easy for a defined contribution scheme to issue a cash equivalent value, because it will be close to the amount of money which has been invested into the scheme by you and your employer. In a defined benefit scheme, where your pension entitlement will depend on the number of years’ service you have accrued, and the amount you are earning when you leave service, producing a cash equivalent value is much more difficult and therefore expensive.
It is important to understand the limitations of the cash equivalent value of a pension. In many cases it will be a large figure, often several hundred thousand pounds. But, despite the name is obviously not literally equivalent to cash. To put it simply the pensioner can’t go to the pension scheme and demand them to hand over that amount of money.
So the cash equivalent value really only helps to compare one pension to another, it does not help you to compare the pension with other kinds of assets like savings, a business, or a house. And sometimes the cash equivalent value is not an accurate way of comparing pensions against each other, particularly if the pensions are very different themselves.
Pensions and unmarried couples
Importantly, the court can only make pension sharing orders (or pension attachment orders) in the context of a divorce or where a civil partnership is being dissolved. This means that it is not possible to adjust pensions in the context of the breakdown of an unmarried relationship.
So, for example, a couple may have been living together in an unmarried relationship for many years, and they may have had children. In many ways, if their relationship breaks down, the issues they face are similar to those they would face if they had been married. But, the court has no power to interfere with their pension arrangements, even if they both want the court to. So if their pensions are very different, they will need to look for another way to address that inequality if they wish to.
This area of the law should probably be re-visited and changed.