Pension Offsetting is a option some couples may wish to consider when settling divorce finances, but it’s a complex area to navigate. We look at the challenges.
What does ‘Pensions Offsetting’ mean?
Where there is a large disparity in spouse’s respective pension provision, the court will look to address that through pension sharing or pension offsetting:
- Pension sharing – is where a portion of the member spouse’s pension is carved off and transferred into the other spouse’s name which they can then drawdown on when they reach the relevant retirement age for that pension scheme.
- Pension offsetting – is where one spouse foregoes their claim (in part or in full) against their spouse’s pension in exchange for more capital now.
The starting point in any financial settlement is an equal division of pension and capital built during the marriage. Offsetting enables an unequal division of capital and pension (one spouse retaining more capital and the other spouse retaining more pension provision).
What are the benefits?
The main advantage is allowing a more flexible settlement structure. Let’s consider a common example:
Spouse A and Spouse B are divorcing. The main assets of the marriage are the family home and a large pension in Spouse A’s name. Let’s say for this illustrative example, both parties are entitled to share in those assets equally.
Spouse B wishes to retain the family home but cannot afford to buy out Spouse A’s interest in it.
The parties agree that Spouse B can keep the family home and won’t have to pay a lump sum to Spouse A, but Spouse A will retain more/all of their pension provision in exchange for not receiving any capital for their interest in the family home.
Essentially, Spouse B is foregoing their claim against Spouse A’s pension provision in exchange for more capital now.
What are the disadvantages?
There are disadvantages to offsetting which is why the court like to keep pension and capital separate from one another but, the court will generally approve offsetting where the parties have agreed to it. The main disadvantages are:
- Capital and pension are not like for like
Pension provision is ultimately an income stream and not a capital asset but this can sometimes be confused particularly when looking at the pension’s cash equivalent value (CEV) which gives a value of for the pension if it were to be transferred to another scheme as at that date. Often parties will agree a settlement structure based on the pension CEVs alone. However £1 in pension CEV is not the same as £1 in cash terms and many CEVs will undervalue the true value of the pension, particularly public sector schemes (like police, NHS, MOD pension schemes). There is therefore a real risk that agreeing a settlement structure using the simplistic approach of £1 in pension CEV = £1 in cash terms now will result in an unfair outcome because the person foregoing their claim against their spouse’s pension may be giving up a lot more than they realise.
Following on from the above example:
Spouse A has a police pension with a CEV of £200,000. The family home is worth £200,000. The parties agree that Spouse B can keep the family home in full (£200,000 cash) and Spouse A will retain their pension in full (£200,000 CEV). However, the police pension CEV is an undervalue of its true worth and so Spouse B is likely to be giving up more than £100,000.
- There is no one method for calculating the offsetting value
When we look at sharing pension provision we often instruct a pension expert to advise on pension sharing options. We can also ask the pension expert to advise on how much cash would be needed now to offset any claim against the pension (i.e. £1 of pension provision = £X in cash terms now).
There is no one method in calculating the offsetting value. Different experts will use different formulas which result in a range of outcomes. So one expert may say £1 of pension = £5 in cash terms now and another expert may say £1 of pension = £10 in cash terms now.
What steps do you need to take?
Firstly, we need to gather all CEVs for all pensions (however small). Some pension CEVs will take a while to obtain (i.e. public sector schemes can take up to 3 months) so requesting these early will be important to avoid delay. We will then be able to assess whether a pension on divorce expert will need to be instructed to advise on pension sharing options. With all the relevant information, an informed and fair outcome may be agreed.
If you have any further inquiries regarding pension offsetting, please feel free to contact our Family Team and we would be happy to help.