When you retire you will want to have enough income to meet your outgoings in retirement. Pension schemes are crucial to this and provide you with that retirement income to ensure that you have sufficient to meet your later life needs.
This is no more important than following divorce, where pensions will prove a crucial factor in disclosure, negotiations and planning for the future.
Why are complex pension schemes so significant in divorce?
Pension benefits are sometimes overlooked by people when they approach divorce, but are often the most valuable asset after the family home. The income they might provide from when they begin paying out at retirement through until the death of the scheme member can be sizeable. They are often index linked in some way, so protected against a inflation. In spite of all these great many benefits, pensions can sometimes be assets that people prefer not to engage with or even think about until retirement age is imminent. When going through divorce, many think about housing and their immediate income needs first and foremost to the detriment of other assets. This can sometimes lead to a divorcee choosing to ignore their spouse’s pension in preference for taking the greater share of the non-pension assets. That is seldom ever a good idea, however.
Why are defined benefit schemes legally and financially different?
The division of pensions on divorce can have a tendency to become a little complicated when either spouse is or has previously been a member of defined benefit pension (DB) schemes. To describe the nature of DB schemes a good place to start is to look at the nature of a defined contribution (DC) scheme, which is far more straight-forward. DC schemes are viewed as a capital asset first and foremost, even if they are designed to provide a retirement income. They are assigned a transfer value which can go up or down from time to time depending on the performance of the underlying pension investments. That transfer value is the single figure provided by the scheme representing the total value of the scheme interest. On reaching retirement, the DC scheme member will either drawdown from the DC scheme or purchase an annuity with the DC scheme’s value that will pay a set income for life.
DB schemes are to be contrasted with this. They accrue not as a capital fund, but rather as an entitlement to income. That entitlement is set by reference to factors agreed upon by the trustees administering the pension scheme. There are many different flavours of DB pension scheme. Each has its own idiosyncrasies and scheme rules, both in terms of how and when the pension is paid, but also how and when it is accrued.
All pension schemes are valued in divorce by reference to the transfer value, commonly referred to as the Cash Equivalent Value, or CEV, (both CETV and CE are sometimes used as variants of this). How the CEV is arrived at between DB and DC schemes is very different. Again, the DC CEV is straightforward. It is the value of the fund based on its underlying investment(s). The CEV will be the total value as shown by the scheme administrators based on the investments in the scheme. For the DB scheme, valuation is a little trickier. The scheme interest is instead assigned a value based on a number of factors in the scheme rules agreed by the pension trustees. These tend to differ from one DB scheme to the next. It is seldom the case that any two are the same. A huge amount of caution therefore needs to be exercised when comparing more than one DB scheme, or indeed, a DB scheme with a DC scheme. It is very much an apples and oranges scenario – depending on the number of DC schemes, a great many more fruit might apply to the analogy.
How are complex pension schemes treated divorce?
This dissonance between DB and DC schemes (or just between DC schemes) are often where specialist family solicitors and actuaries come into their own. Instructing a solicitor familiar with the distinctions between the main DC schemes can assist with planning a strategy and making sure the rights questions are asked. The actuary is needed, given that the measurement of scheme interests and entitlement in a DC scheme relies on an assessment of actuarial factors, such as life expectancy and rates of return. Approaching the division of a DC scheme interest without the assistance of either a specialist pensions on divorce solicitor or an actuary can result in difficulties later on.
What are the options for dividing pensions in a divorce settlement?
The most common means of dividing pensions on divorce is through a pension sharing order. This removes a portion of the pension member’s benefits and transfers it to the divorcing spouse. In England and Wales, the portion shared is always expressed as a percentage of the scheme it has been sourced from, i.e. a 50% pension sharing order. Sometimes more than one pension sharing order is used to bring about the outcome the couple have agreed.
A less common means of approaching the division of pension is through earmarking. This leaves the pension member’s interest intact, but compels the scheme to pay a proportion of it to the divorced spouse for as long as the member is alive. It can be expressed as a proportion of the pension income, the pension lump sum, or sometimes both. It is far from ideal, given that the arrangement will only last for as long as the pension member is alive. In contrast, pension sharing orders survive the death of the member spouse. Sometimes however, particularly with overseas or some offshore pensions, earmarking is the only option available.
The other option for dealing with pensions is to offset. At its most extreme, this involves one of the spouses agreeing to take more of the non-pension capital leaving the other spouse to retain the pension. It is possible to set up a partial pension sharing, partial offsetting arrangement if that would better suit the couple. Offsetting can be incredibly difficult to get right. Again, this comes back to the apples and oranges situation, and not knowing for how long each spouse is going to live, (a crucial variable in the offsetting calculation). The only certainty with the offsetting calculation is that it is going to be wrong, however that does not mean that it isn’t of attraction to some couples.
Many members of DB pension schemes tend to want to explore offsetting more, since they know how valuable their pension interest is. They recognise that the inflation proof income from a given retirement age rolled up over life will amount to a significant sum that it is often going to be worth trying to retain. Conversely, many spouses of DB scheme members also recognise the weight their spouses attach to their scheme memberships, and this can be used in certain situations to leverage a better settlement.
Mathematically, the only safe way of approaching DB pension schemes to avoid disenfranchisement and achieve a parity of pension division, often appropriate in divorce, is to look at pension sharing.
How do career structures and service rules affect divorce outcomes?
Final salary pension schemes were the most common type of scheme of public sector pension scheme for many years. These would use the final salary of the scheme member to calculate the eventual pension benefit. For example, the NHS 1995 scheme calculated its benefits based on 1/80th of the final salary of the scheme member for every year of service.
All major public sector schemes were reformed in 2015 to remove final salary pension benefits. For example, the 2015 NHS scheme transitioned to career average earnings, providing 1/54th of that CARE figure for every year of service. The old final salary schemes routinely produce significantly higher benefits for many longer serving or late career high earning employees than the newer CARE benefits.
The 1995 also allows its members to opt for partial retirement and to begin drawing down part of their pensions whilst still working. This can alleviate the need for maintenance to be paid until they fully retire in some instances.
Each DB scheme will have its own scheme rules and regulations that need to be carefully considered if there is going to be a divorce. The non-pension asset pool can often be far more agile than the pension interests and used to support or buffer nuances in the individual schemes or their sharing. The best financial divorce outcomes are ones where all assets work in harmony to provide each of the parties with a stable financial future.
How can cross-border factors complicate pension division?
Great care needs to be taken if there is an overlap of any type between England/Wales and another jurisdiction. An overseas posting might bring with it an entitlement to commence divorce proceedings in that jurisdiction, as the habitual residence and potentially also the domicile of one of the parties to the divorce changes. If the DB pension is administered in England and Wales and there is an overseas divorce it may prove incredibly difficult to seek a share of that pension. That may suit one of the parties to the divorce, but it is unlikely to be helpful to the spouse seeking a pension sharing order. It will pay to be vigilant here.
Where a UK administered pension is in play, it is generally going to be preferrable to secure England and Wales as the divorce jurisdiction so that the pension can be divided properly.
If proceedings are commenced overseas, then care needs to be taken around how the English pension is treated or even referred to.
When considering the impact of a pension sharing order on an overseas resident, it would be prudent to consider taxation and how the pension might be treated in their country of residence. It is possible the pension income will be taxed both in the UK and in the overseas jurisdiction, so if future overseas residence plans are known at the time of divorce it is important that is flagged so it can be accounted for.
How can private wealth protections help public-sector professionals?
Pre and post nuptial agreements are often used, particularly in the cases of second marriages or large age differences, for example, in order to protect pensions accrued prior to a marriage. These agreements are not legally binding on divorce, but do carry persuasive weight if ever the couple go their separate ways. They can be helpful in raising and addressing financial uncertainties and misgivings that can sometimes exist but remain unspoken at the outset of a relationship and clear the air of what might otherwise be distracting concerns.
I tend to see couples agree premarital pensions will be preserved in the event of divorce or that the entirety of the pension will be disregarded in its entirety. Sometimes that is agreed in recognition that there is a widow’s entitlement or death in service benefit that the surviving spouse would otherwise benefit from. The rationale is sometimes that those death benefits to the spouse are “offset” through the provision being preserved for the scheme member in the event of a divorce.
What should professionals in Cornwall, Devon and Somerset consider locally?
The warning and information covered in this article apply as much to DB pension scheme members in Cornwall, Devon, Somerset and Dorset as much as they do anywhere else. The need for advise when considering or going through divorce from specialist solicitors with a knowledge of the scheme nuances and specifics is going to be incredibly helpful when planning how to approach settlement on divorce.
This is no better demonstrated by reference to the MET Office, the national office for which is based in Exeter.
The MET office pension scheme is a UK Civil Service employer and its staff belong to the Civil Service Pension Scheme. The Civil Service scheme operates different sections depending on when the scheme member joined, split between classic, nuvos and alpha. These are broadly equivalent to the 2015 rules applied by NHS, referred to above, whereby all members were moved into the CARE based schemes unless they were protected by transitional rules.
How can individuals protect their financial future?
The best advice one can give in relation to the treatment of pensions is often to seek a share of the non-pension assets completely separate from the share of pension assets that is going to be needed. That way one can ensure they are getting their fair share of each different class of asset.
Andrew Barton is a divorce and financial remedy specialist solicitors top rated in Legal500 and Chambers & Partners for advising and representing clients in relation to financial remedies on divorce. He was a contributor to the Guide to the Treatment of Pensions on Divorce by the Pensions Advisory Group, published in 2024.
If you need advice on this please get in contact with our Family Law team.