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Value of pensions on divorce
On divorce, the couple is required to provide valuations of each of their pensions. For defined contribution schemes, this is simple, and you will often be able to obtain one instantly by accessing your on-line account with your pension provider. The valuation will be automatically calculated in reference to how much has been saved via contributions and the current value of the investments which have been purchased by the pension provider.
The value of a defined benefit pension is more difficult to calculate because there is no actual pot of money in an account or in investments belonging to the scheme member. Instead, the pension is valued in two stages:
- By calculating what benefits the member will be entitled to on retirement including both income and lump sum, and then
- Working out, by reference to assumptions about market returns, taxation, and life expectancy, how much the scheme would need to have now in order to provide those benefits in the future.
Who calculates the value of pensions when divorcing?
This mind-boggling task is completed by an actuary. Organisations like the NHS have their own in-house pension administrators who provide valuations, and the scheme member is entitled to one such calculation each year free of charge. Unfortunately, most actuaries agree that such schemes tend to be under-valued on divorce, meaning that where you have a mix of pensions, you would not be comparing like with like if you accepted at face value what you are told about the value of your defined benefit scheme. This is particularly true if the mix involves defined contribution, as well as defined benefit, schemes.
Often, when it comes to divorce, it is necessary for the couple to obtain joint advice from their own actuary as to the value of the pensions before they can begin to discuss how the pensions should be shared. The jointly instructed actuary will value each of the pensions on a consistent basis, using the same methodology and the same assumptions.
Once that exercise is complete, the couple can agree the way forward, but what should that be?
How should pensions pots be divided on divorce?
The starting point in a long marriage is that the pension should be shared equally. This is, however, all part of a bigger picture, and you should always take legal advice as to your financial claims as a whole. Even equality has its uncertainty though. For example, does the couple want to achieve equality as to the value of their respective pensions? Or do they want to ensure that they get the same income on retirement?
Generally speaking, the younger the couple, the less appropriate it is to seek to achieve equality of income on retirement. These couples will probably look to equalise the value of their respective pension pots. The actuary will be able to advise what this might look like in terms of outcome – ie what their respective incomes might look like on retirement.
By the time the couple is in their late 40s, and certainly by the time they are in their 50s, they will generally be looking to equalise their incomes. The actuary will calculate how they will need to share their pensions in order to achieve this outcome. Their advice will include how to maximise the parties’ pension income overall, which may not be the most obvious way.
What happens after an agreement has been reached over how to share pensions on divorce?
Once the couple has agreed how to share their pensions, they need to have that agreement incorporated into a court order, and the order needs to be made within divorce proceedings, or proceedings for the dissolution of a civil partnership. Pension providers cannot implement the agreement without a court order.
Pension sharing is then achieved by means of the relevant deduction being made from the person with the largest pension pot and that deduction being paid into the pension scheme nominated by the other party. This payment is called a pension credit.
At this point, the person receiving the pension credit will have to decide where the pension credit should be paid, and they should take independent financial advice about this. It may be that the pension credit will be paid into a new scheme, or it might be paid into the receiving spouse’s existing scheme.
It is not possible to transfer the pension credit out of public sector schemes. In these cases, the pension credit will simply be transferred into the receiving spouse’s name and they will become a member of that scheme. That is often beneficial to the receiving spouse, who then gets all the benefits of a defined benefit scheme.
The pension sharing order itself is a technical document. It must include all the information required by both the court and the relevant pension provider, and it must (unless the pension provider has already had the opportunity to make representations to the court) be served on the relevant pension provider before being submitted to the court for approval. An expert family law solicitor will be able to guide you through this process and ensure that the documents are drafted and served properly.
Assuming the court approves the order, it does not come into effect for 28 days after the order is made. This could cause problems if the person whose pension is being shared dies after the order is made but before it comes into effect. Again, specialist advice should be sought about the ways and means of protecting the other spouse in these circumstances.
The pension provider will then require the relevant documents, including the court order and the final divorce order. They have three months from receipt of all such documents in which to implement the order.
Types of pension
In essence, there are two types of pension (although there are many variations, some of them less apparent than others):
- The defined benefit scheme and
- The defined contribution scheme.
The first of these might also be referred to as a final salary pension or a career average pension. These are typical of the public sector, including the NHS, the armed forces, teachers and the police. They used also to be a feature of jobs with large companies, such as IBM and Fujitsu, but over the years these companies have closed their final salary schemes and migrated members to defined contribution schemes.
Defined benefit pension scheme
The beauty of defined benefit schemes is certainty. You will know what you will be getting in retirement, and it will usually bear some relation to what you got during your working life. It will also be linked to some form of inflationary measure so that your income in retirement will increase in line with prices.
Defined contribution pension
By contrast, a defined contribution scheme provides benefits which are dependant on the value of the pension at the date of retirement. Most people in employment will make automatic monthly contributions via their employer, who will deduct the relevant amount from their gross salary and add their own employer contributions in addition. The pension provider will use those contributions to invest with a view to growing the total value of the pot. By the time the employee reaches retirement age, their pension will likely comprise a whole host of underlying investments in stocks and shares, gilts securities.
At that point, the underlying investments are sold by the pension provider, and the proceeds used to purchase an annuity, which is an income for life, or for a fixed term of years. The amount of income purchased in this way will depend on whatever the pension pot was worth at the point of retirement and may not be linked to inflation. You can’t predict with a great deal of accuracy in advance of retirement what the pot will be worth.
It is not always appropriate or necessary to share pensions. Neither is it always necessary to take advice from an actuary. If you are going through a divorce in which pensions are a feature, you should take advice from a specialist family lawyer. That, compared with expert financial advice, will help guide you through this complex part of your divorce.
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