Pensions and Divorce
Note: For UK residents only.
Divorce can be one of the most significant events to shape your financial future, but many people don’t realise that pensions are often one of the largest assets at stake – sometimes even more valuable than the home the family live in.
Pensions are an important part of the list that makes up marital assets (your overall family wealth). Not understanding their true value both now and in the future, and the options to share them, can have a big impact on your standard of living both post-divorce and for years to come.
If there’s an imbalance in pension splitting, you may face retiring on a fraction of your ex-spouse’s pension when you could be entitled to more.
In this article we explore the different types of pension and methods of pension sharing, key considerations and crucial planning steps when managing a divorce.
Legal considerations
Where you are in the UK can affect how pensions are approached in a divorce. In the UK, pension rights built up by either spouse are generally considered part of the matrimonial assets to be divided on divorce. In England and Wales, all pension rights belonging to either party (except specific exclusions like the basic State Pension) are usually taken into account. In Scotland, only the portion of pension rights built up during the marriage or civil partnership is considered.
There’s a duty for both parties in a divorce to fully disclose all of their assets during a divorce, including all pensions. It’s worth seeking advice if you are at all unsure about this and make sure all assets are included before you start to negotiate.
Mediation and managing divorce
Often families manage to negotiate their separation via mediation. This is great and certainly worth looking into, so much so that recent legislation has tried to encourage it. The recent introduction of no-fault divorce was designed to help couples divorce without assigning blame, and the process is often faster and more straightforward. It’s important to remember that this does not change the fundamentals of how finances are divided.
All assets must be considered, so don’t be put off by perceived “complications” around obtaining pension values. A good advisor or the provider will be able to help you get the information you need. If you are using mediation, you may still need financial advice and should ensure all assets are taken fully into account.
Reportedly, pension sharing is decreasing[1] and anecdotally family mediators and lawyers express concern this is due to pensions being forgotten as an available family asset when negotiating the split.
In terms of professional guidance, look for an advisor that’s Chartered. This means they hold the highest level of qualification. They will be able to explain the nuances of the schemes within your family and will likely offer you a cashflow to demonstrate the impact of different schemes on your future financial security. It’s important to build a team around you; include a Chartered Planner as well as a mediator and often a good family lawyer.
Try to establish what overall wealth is, before you start proceedings (it can quickly get very stressful, especially where children are involved). Do your homework ahead of time. According to Relate[2], money worries can be a significant factor in divorce, so being open about family finances and engaging might even open a dialogue which helps prevent divorce.
Types of pension
There are three main types of pensions that may come into play in a divorce:
- Private and workplace pensions: An easy way to think of these is to ask yourself the question – does their value depend on how much you put in and how much it grows? If yes, it’s likely you are looking at a defined contribution (DC) pension (like personal or stakeholder pensions, and workplace money-purchase schemes). If the answer is no, the value relates to the numbers of years worked then it’s likely you are looking at a defined benefit (DB) pensions (such as final salary or career-average schemes, common in public sector or older workplace schemes).
- Defined benefit (DB) pensions (e.g. old style company final salary scheme) can sometimes provide a cash value (known as a CETV) that can undervalue the real benefit to an individual. These type of pensions promise a guaranteed income for life, which can be very costly to buy. The cash value may not show other more hidden benefits such as generous index-linked benefits or payments to surviving spouses etc. Taking advice and knowing what pensions the family has should help with this.
- For defined contribution (DC) pensions (which accumulate a fund value), the fund value is clearer than in defined benefit schemes, but you should still account for taxes on withdrawal and the fact that pension funds are not readily accessible until a certain age. In any case, including up-to-date valuations of all pensions in financial disclosure is an essential first step.
Don’t forget about your State Pension
www.moneyhelper.org.uk is a UK government website that talks all things finances. It has great, clear information on Pensions, including things to consider when you are divorcing and especially around the State pension.
Whilst most pension rights can be divided, including any earnings-related State Pension components (like SERPS or State Second Pension) and any extra “protected payment” under the new State Pension, certain pension entitlements are excluded from sharing – notably the basic State Pension and the standard new State Pension.
Almost always overlooked in a divorce is a quirk in the State Pension system. If you reached State Pension age before 6 April 2016 (under the old system), a divorced person may claim a State Pension based on their former spouse’s National Insurance record, as if still married, to potentially increase their entitlement. This aspect can be complicated – but very valuable. Specialist advice is often needed in this area.
Splitting pensions during a divorce
Whatever the type of pension scheme you have, they can all be considered in a financial settlement. The tax treatment and the best way to build them into your financial plan will vary. It’s vital that you take financial advice to confirm the types of schemes you’re looking at.
So how are pensions split in divorce? UK courts aim for a fair distribution of assets, guided by principles of need, compensation and sharing. There is no discrimination between breadwinner and homemaker – both contributions are equal.
Pension sharing order
Pension Sharing Order (PSO): A PSOis the most common method for splitting pension benefits after divorce. This piece of legislation was introduced in 2000 and provides a clean break as the court orders that a percentage of one person’s pension value is transferred to the other party. The spouse receiving the share becomes entitled to a pension credit in their own name.
A PSO allows each party to take a share of the pension which they then control themselves from that point onwards. Financial planners are often asked to help implement this by opening a new pension ready to receive the funds. This can take around four months and the pension company will want all the documents signed and sealed before they start work on the transfer. They usually charge an Implementation Fee.
This method enables a clean break as once the transfer is done, each person controls their own pension pot and neither will be affected by the other’s death or remarriage later.
Pension sharing is not available for unmarried cohabiting couples (who have no automatic financial remedy rights under current law). It applies in divorces of marriages and in civil partnership dissolutions only.
Pension offsetting
Pension offsetting: This isn’t a court order applied to the pension itself, but rather a way of reaching an agreement. Offsetting means one spouse keeps their pension intact, and in exchange the other spouse receives a larger share of other assets (such as property or cash) to balance the overall fairness. For instance, one spouse might keep the entire £200,000 pension fund, while the other keeps the £200,000 house – thereby “offsetting” the pension against the property.
The advantage is simplicity and a clean break (no need to involve pension trustees or split the fund). But valuing the offset correctly is critical. A pound in a pension is not the same as a pound in equity in a house or savings account.[3]
It’s important if you are considering this option that a Chartered financial planner, or a pension specialist reviews things and helps you value the pension according to its true worth.
Financial settlements
Some couples opt to dissolve their marriage without a financial settlement in place if they believe they can sort their finances between themselves. However, this may not be the most secure option. If a financial settlement is not legally agreed upon in court, both individuals can make claims on income and assets years after. These unresolved financial matters can be a cause for disputes and stress down the line, impacting any future relationships and compromise things like retirement plans.
Planning for a future after divorce
It’s never too early to think about what your finances need to look like after the divorce so here’s a quick to do list which might help if you’re receiving a pension share:
Decide where it will go: do you need to set up a personal pension to receive the transfer? (Your financial planner can help find a suitable arrangement to transfer the credit into).
Investments and tax: Review your investment strategy for that pension money (based on your age, attitude to risk and overall wealth). A financial planner can also use cashflow modelling tools to ensure your finances are as tax efficient as possible post-divorce. This means making sure you take full advantage of allowances such as ISAs.
Estate planning: After a separation, make sure you review your estate plans, insurance coverage and pension arrangements. This will help to ensure they reflect your new situation. A blend of financial and legal guidance can help you align your overall financial strategy with your updated needs and goals.
In our recent article here, we provide more helpful tips on how to continue on a robust financial journey post-divorce, and how we can help you.
Conclusion
Recent tax and pension changes generally reinforce the need to treat pensions carefully during divorce. With easier divorce processes, there’s a risk of missing pensions and with evolving pension laws, there are new opportunities (and complexities) to consider. Staying informed on these changes and seeking advice is crucial.
To protect your assets and future self, a financial planner can help to ensure you are offered a fair settlement when it comes to dividing up any pension benefits during divorce.
They can also continue to look after your assets in the next phase of your life. If you are in the process of divorce and are looking for financial support, please don’t hesitate to contact us.
FAQ’s
House vs pensions in a divorce?
With divorce, it’s often the case that one party takes the pension asset and the other takes on the property. However, this can leave both parties in a risky position – one in pension poverty and the other subject to the fluctuation of the housing market.
What happens with my savings and investments in a divorce?
Investments and savings are distributed as fairly as possible, but this doesn’t always mean a 50-50 split. All savings and investments accumulated by both parties in the marriage will be considered for distribution.
Can my ex-partner make a claim on my pension?
The short answer is yes, if you have not agreed otherwise in your financial settlement agreement and have no clean break order in place, your ex-partner can make a claim on income and assets – including your pension.
[1] Pension Sharing on Divorce/Dissolution of Civil Partnerships In England & Wales, MSB.
[2] Money is top strain on relationships, Relate, 2017.
[3] www.actuariesforlawyers.com
Important Note
The information contained within this document is subject to the UK regulatory regime and is therefore primarily targeted at consumers based in the UK.
This article is distributed for educational purposes only and should not be considered financial advice.
If you are unsure about the suitability or otherwise of any product or service, we recommend that you seek professional advice.
The opinions stated in this document are those of the author and do not necessarily represent the view of Progeny and should not be relied upon to make a financial decision.
Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Please note
Tax treatment depends upon individual circumstances and is based on current UK tax legislation, that is subject to change at any time.
Past performance is no guarantee of future performance.
The value of an investment and the income from it can fall as well as rise and investors may get back less than they invested. Your capital is therefore always at risk. It should be noted that stock market investing is intended for the longer term.
