What happens to pensions following a divorce?

When a married couple separates, the court has wide powers to make orders in respect of all forms of assets – including capital, pensions, and income. It is a common misconception that capital assets (such as savings or equity in property) will be shared, whereas pension assets will be retained by each party. The reality is that, as a starting point, the court will assume that both capital and pension assets should be shared equally.

The court has the power to make what is called a “pension sharing order”. That involves transferring a percentage of one party’s pension out of their scheme and into a separate scheme held in the name of the other party. Pension sharing allows spouses to separate their pension assets at the time of divorce, instead of remaining financially linked to one another until (or beyond) retirement. The outcome of pension sharing is that both individuals will have their own separate and distinct pension pots (with separate lump sum and income provisions).

If there is a disparity in pension assets, it is possible to consider “offsetting” as an alternative to pension sharing. Offsetting involves the spouse with the smaller pension receiving a higher proportion of the capital assets, in exchange for foregoing their claims against their ex-partner’s pension.

Pensions are one of the most difficult assets for family lawyers and courts to grapple with. That is in part because of the unreliable nature of the Cash Equivalent Transfer Value (“CETV”) attributed to pensions. CETV figures are an estimate of what it would cost to purchase a similar pension on the open market. However, the methodology that is employed to assess a pension’s CETV is complex and varies between pension providers. As a result, CETV figures can be misleading. That is particularly true of public sector / final salary pension schemes.

Annual pension forecasts also have very limited value. They essentially set out what an individual’s pension lump sum / income may be, assuming they continue to contribute to the scheme at the current rate. That is a “crystal ball” estimate for those to whom retirement remains a remote prospect.

Negotiating a divorce settlement whilst relying purely on CETV figures can produce unfair outcomes. The Pension Advisory Group recently published updated guidance which used the following example:-

1. Imagine a case in which a wife has an NHS pension with a CETV of £156,300. That pension provides her with a lump sum of £22,500 and an income of £7,500 per annum.
2. The husband has a defined contribution pension with a CETV of £200,000.
3. On the face of it, the husband’s pension pot is worth more. The wife therefore appears to be entitled to either a pension sharing order (to achieve equality in respect of pensions) or a larger share of the capital assets (to “offset” her apparent claims against the husband’s pension).
4. In reality, if the husband takes a £22,500 lump sum from his pension (to match the wife’s lump sum) his pension income will reduce to £5,200 per annum as compared with the wife’s income of £7,500 per annum.

In the above scenario, what appears at first glance to be a fair outcome (i.e. the wife receiving slightly more capital to account for her “lesser” pension) is actually unfair for the husband; he is exiting the marriage with less than 50% of the capital, in exchange for the privilege of retaining a less lucrative pension!

There are some circumstances in which it is appropriate to negotiate a divorce settlement / consider the division of pension assets whilst relying on CETV figures. However, in many cases (including but not limited to those involving public sector pensions; pensions with implicit guarantees; pension assets which are likely to exceed the Lifetime Allowance; cases in which one party has a serious medical issue; and pensions with a capital value of more than £100,000 collectively) it is strongly advisable that divorcing couples receive advice from an expert actuary, to ensure that any settlement they are considering will produce a genuinely fair outcome.

In summary, pensions are a complex form of asset. The court has wide powers to distribute assets following a divorce, and there are various ways to address a disparity in pensions. However, achieving a fair outcome is seldom as straightforward as dividing a CETV figure by 2. It is important to take expert advice, to ensure that any settlement agreed is fair to both parties.

Antonia Wiliamson is a Senior Associate in the Family Law team at Freeths. If you have a query concerning financial issues following divorce, or another other family law matter, please do not hesitate to contact Antonia on 0345 274 6855.