Options available for Pensions on Divorce
There are typically three options open to consideration when looking at how to deal with pensions on divorce. These are pension sharing, pension attachment or offsetting. Below, we take a brief look at each in turn and highlight the main pro's and con's
Pension Sharing Orders:
Pension sharing is one of the options available on divorce or the dissolution of a civil partnership. It provides a clean break between the parties as the pension assets are split immediately upon implementation of a pension sharing order. This means that each party can decide what to do with their share independently
How do they work?
The Court will issue a pension sharing order (PSO) which states how much of the pension, the ex-spouse or partner is entitled to receive. The amount is expressed as a percentage of the cash equivalent value(s) of the pension(s) that are to be split.
For example, if the value of the pension was £100,000, a 50% share would give each person £50,000 each.
A Defined Benefit pension arrangements may offer two options for sharing: -
An Internal Share – where the ex-spouse has benefits established within the same scheme that the share is coming from.
An External Share – where the ex-spouse has to transfer the value awarded by a Pension Sharing Order into a pension in their own name – this will be a defined contribution arrangement.
Public Sector schemes offer an Internal Share and most Private Sector schemes will only offer an external share.
A Defined Contribution schemes will typically only offer an external share.
Pros and cons of pension sharing
Pros
· It achieves a clean break as far as pensions are concerned.
· It can help to make sure that both parties have some pension provision in retirement.
· Remarriage, death, or other change in circumstances will not affect the order.
Cons
· There will usually be a fee to pay to the pension scheme provider to implement an order.
· It might be difficult to split some pensions e.g. those that contain illiquid assets like commercial property.
· There may be additional complications with tax and the Lifetime Allowance.
Attachment Orders:
A pension attachment order redirect’s part or all of the member’s pension benefits to the ex-spouse or civil partner when it comes to be paid.
This doesn’t provide a clean break, as an ongoing link with your ex-spouse or civil partner will remain.
How do they work?
Pension attachment allows the courts to make an order stating that part, or all, of the member’s pension benefits (excluding state pension benefits) must be paid to their ex-partner when they become payable. The pension still belongs to the scheme member, but the scheme must make some form of payment to the ex-partner when the member’s benefits become payable.
The court can order that the ex-partner receives one, or a combination, of the following benefits:
· all or part of the member’s pension income (this doesn’t apply in Scotland)
· all or part of the member’s tax-free cash sum
· all or part of any lump sum paid in when the member dies.
Taxable income payable to an ex-partner still belongs to the member, so will be taxed as if it’s being paid to the member. Payments won’t count as taxable income for the ex-partner and shouldn’t need to be declared as income for tax purposes to HMRC.
Pros and cons
Pros
· It allows for both the tax-free cash benefit and the pension income benefit to be earmarked.
· Death-in-service benefits can also be earmarked.
· If the member transfers pension rights, the earmarking order will follow the member’s rights to the new arrangement.
· The ex-partner will have some provision in retirement.
Cons
· It doesn’t allow a clean break between the couple, and the couple might need to keep in touch for many years after the divorce/dissolution.
· There’s uncertainty about the eventual payment of the benefits. If the scheme member dies before retiring, or if the ex-partner marries or forms a civil partnership, any earmarking/attachment order (other than for lump sum death benefits) usually falls away.
· The earmarked payments don’t start being paid until the member retires. And there’s no particular date they have to start taking income. If the ex-partner is older than the member or if the member delays their retirement, this might have financial implications for the ex-partner.
· The payments stop on the member’s death, leaving the ex-partner without that income for the last years of their life.
The drawbacks of this option has meant that attachment orders are rarely used.
Offsetting
When divorcing or dissolving your civil partnership, all your assets and those of your ex-partner are taken into account. If you decide to opt for pension offsetting, each party keeps their pension assets. But these are then offset against the other assets – for example, if one person has a large pension pot, the other might retain the house.
An offsetting calculation may be deemed necessary to help put a fair value on pension assets not shared.
Pros and Cons
Pros
· It keeps things simple.
· One party might need to use other assets (for example, a home). It can be hard to value some assets as their values might change at different rates.
· If the pension is small, making a pension sharing order could be expensive and might not be cost-effective. It can be difficult in some situations to divide assets fairly using pension offsetting, especially as the value of a person’s pension schemes might, in the long run, be their most valuable asset.
· Offsetting is not affected by remarriage or death.
· This might be a good option if there are overseas pension assets that need to be split, as these cannot be shared via a UK court order.
Cons
· One person might be left with little or no provision for retirement.
· It can be hard to value some assets as their values might change at different rates.
· It can be difficult in some situations to divide assets fairly using pension offsetting, especially as the value of a person’s pension schemes might, in the long run, be their most valuable asset.