Pension sharing on divorce
January is “divorce month”. Whilst this may be good news for family law practitioners, there are serious risks of getting the advice wrong and potentially losing hundreds of thousands of pounds for your client if your pension sharing on divorce advice is lacking.
See this article from Professional Adviser.
It is important to be aware that the Cash Equivalent Transfer Values (or CETVs) of defined benefit (or DB) (e.g. final salary) schemes can be calculated by different schemes using very different assumptions. This can lead to identical pension promises in different schemes having vastly different CETVs. A pension of £15,000 pa to a 65 year old male may have a CETV of £250,000 in one scheme and £500,000 in another. It follows that simply splitting CETVs is unlikely to produce an impartial outcome.
If the parties wish to equalise incomes this cannot easily be done without taking expert advice. Equalising incomes may sound a straightforward concept but there are many factors to consider, such as retirement ages, the equalisation date, the life expectancies of the parties and ancillary benefits such as death benefits and pension escalation rates. We advised on a case recently where equalising incomes resulted in one party ending up with 2/3rds of the pension assets by value! Whilst this may have been the desired outcome, it is important that the parties are aware of such issues before agreeing a settlement.
Equalisation by value
If, on the other hand, equality of value of pension rights is sought by both parties, it may not be unreasonable to split the total CETVs if all the pension schemes in the marriage are defined contribution (or DC) (also known as money purchase) arrangements, without any form of guarantee. This approach may also be reasonable if there is only one scheme which is DB and it provides a pension credit within the scheme to the spouse. However, if the DB scheme will only provide an external transfer to the spouse, or there is more than one scheme and some of those are DB schemes, or the DC schemes have guarantees such as guaranteed annuity rates, then splitting pension assets by CETVs is unlikely to be fair. In such cases we would suggest that consistent market-related actuarial values of all the schemes are sought.
To avoid splitting the pension schemes, the pension values are sometimes used for offsetting against other assets. However, the promise of a pension worth £300,000 is not the same as having a house worth £300,000 or £300,000 in cash now. There is the real danger of comparing apples and pears. Ideally “market values” of all assets are required. It is usually appropriate to discount the pension value to allow for the fact that it is taxed as earned income. Furthermore, the parties may wish to discount further to reflect what is known as “utility”, e.g. how much use a pension asset is to the recipient now – if the receiving party needs cash, a future pension promise may be virtually worthless. We have developed a technique to identify an appropriate level of discounting.
The only way to truly understand all the relevant issues when splitting pension assets, and to minimise the risk of providing poor advice, is to ask an expert in pensions on divorce. Contact us if you require further information or would like to discuss some of the issues raised in this note.