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20 min read 5 Oct 21
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.
When considering pensions and divorce, it’s important to look at the legislative background to understand the changes that have taken place.
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.
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.
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.
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:
The Act also made it compulsory for courts to take pension rights into account when determining the value of the matrimonial estate.
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.
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.
To help simplify the explanations, assume that:
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:
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.
What can be earmarked in England, Wales and Northern Ireland:
What can be earmarked in Scotland:
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:
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.
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).
When the pension provider / trustees get a pension sharing order:
Please also note that the FCA clarified in Finalised guidance FG21/3 Advising on pension transfers that advisers do not need transfer permissions if they advise an ex-spouse whether to use a pension credit awarded from a pension sharing order to acquire rights in a DB scheme. The Department for Work and Pensions told the FCA that where the ex-spouse has the option of becoming a member of a DB scheme, the pension credit is not regarded as safeguarded benefits (or money purchase or cash balance benefits) or a transfer payment but as a right in itself. If an adviser advises an ex-spouse on using the pension credit to acquire rights in a DB scheme, this falls outside FCA-regulation. But if they are advised on acquiring rights in an FCA-regulated DC scheme, advisers must have the relevant investment advice permission.
Where offsetting applies, legislation has no direct impact, as these financial arrangements work outside the pension scheme.
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:
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.
Finance Act 2014 Schedule 6 part 1
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.
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:
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.
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.
To help ensure a clean break the ex-spouse will probably:
This may be possible and depends on whether the scheme rules allow pension credit members.
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.
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.
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.
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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