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Pension Options on Divorce - Pension Sharing

15/11/2023

Pension Sharing

Pension Sharing is an option on divorce or dissolution of a civil partnership. It can be used when proceedings started on or after 1 December 2000. 

In England, Wales and Northern Ireland, pension sharing must be formalised in a pension sharing order issued by the court. In Scotland, pension sharing may be activated by either a pension sharing order issued by the court or a qualifying agreement.

The pension sharing order allows a clean break between the divorcing couples, as some or all of the pension is passed from the scheme member to their ex-spouse. The amount to be transferred will generally be expressed as a percentage of the member’s cash equivalent (CE) value, although in Scotland, it can instead be expressed as an amount.

Most pension rights are shareable, regardless of whether they are in payment or not. Shareable rights include occupational pension schemes, personal pensions, retirement annuity contracts, lifetime annuities and the additional (SERPS/S2P/Protected Payment) element of the State Pension. 

Non-shareable rights include death benefits, pension rights that already have an earmarking order placed on them and elements of the State Pension that aren’t related to the Additional State Pension.

An overview of the process

Typically, pension sharing will broadly follow the below process:

  • Basic information about the pension will be gathered. This will include details of how sharing is dealt with under the scheme, any applicable charges and a valuation – the ‘cash equivalent’ (CE). 
  • Based on the information gathered, the Court decides (or the divorcing parties agree) how much of the members pension rights will be transferred to the ex-spouse. 
  • In England, Wales and Northern Ireland, the court order, including the pension sharing annex, must be sent to the trustees or managers of the scheme within 7 days of the later of:

    • the date of the order, or
    • the date of decree absolute / final order of divorce.
  • For orders or agreements made under Scottish law, if the pension scheme does not receive certain documents within two months of the date of extract, the pension sharing order/agreement is deemed never to have taken effect.
  • Once received, the scheme reduces the members pension rights by the percentage / amount specified – the “Pension Debit”. In turn, these rights are allocated to the ex-spouse - the “”Pension Credit”
  • Depending on what options the existing pension scheme offers, the ex-spouse will be able to use the pension credit to either:

    • join the existing scheme; and/or
    • transfer the pension credit to another registered pension scheme*.

*Note that although referred to as a transfer, this is not classed as a ‘recognised transfer’ under S169, FA2004 

Impact of the pension debit on the member

The pension debit reduces the members pension rights. However, there is no enhancement to the annual allowance to enable the member to rebuild the lost pension. 
Where the member holds Primary Protection or Individual Protection (IP14 & IP16), the protection is reduced by the amount of the pension debit. This can mean protection is lost completely if benefits are reduced by more than the protected amount. 

Impact of the pension credit on the ex-spouse

The pension credit provides the ex-spouse with a pension in their own right and will be tested against their lifetime allowance when taken. Receipt of a pension credit will not however impact their annual allowance or ability to make further pension contributions.

If the pension credit arises from a pension in payment, it is classed as a disqualifying pension credit. This means that the pension credit will still be treated as uncrystallised funds when discharged to the ex-spouse, but no tax free cash will be available.

Where a disqualifying pension credit arises from post A-Day crystallised rights, the ex-spouse can claim a lifetime allowance enhancement (the pension credit factor) equivalent to the disqualifying pension credit received.

Potential pitfalls with pension sharing orders

Although the introduction of pension sharing represented a big step forward over earmarking orders, there can still be some issues that can occur. Some areas that need to be considered include:

  • Drafting errors – In some instances, pension sharing orders will contain drafting errors, such as an incorrect pension scheme name or reference (plan) number. Where the errors are severe, the order may need to be corrected, increasing costs, delaying implementation and wasting court time. 
  • Valuations - The pension debit is based on the valuation at the ‘valuation day’ (a day chosen by the scheme within the 4 month implementation period). For money purchase schemes, fluctuations in fund value during this time can mean either party is left with considerably more or less than originally expected. 
  • Illiquid assets – If the pension contains illiquid assets such as commercial property or loans, these may be difficult to value or sell, causing problems in implementing the order.
  • Normal minimum pension age – The ex-spouse will still not be able to access the pension credit until they have reached minimum pension age. Where there is an age gap between the former couple, this may mean that benefits previously in payment can no longer be accessed.
  • Obstructive party – Where the parties are not on good terms, one party may decide to frustrate the implementation of the order by refusing to pay their share of costs or by not providing details of the scheme they wish the pension credit to be paid to. This can effectively mean neither party can access the pension, since the implementation period cannot begin until the trustees are in receipt of all the information needed to implement the order.
  • Overseas resident spouse – The pension credit needs to be paid to a ‘qualifying arrangement’ (in practice, a registered pension scheme or a QROPS). Where the ex-spouse is resident overseas, it may prove very difficult to find a suitable scheme that will accept the payment. This can be further complicated by the fact that the transfer is not classed as a ‘recognised transfer’. 

Comment

Auto-enrolment, rising stock markets and high defined benefit valuations mean pension rights form a high percentage of many couples’ total wealth. Many divorcing couples will therefore find that offsetting won’t be appropriate.

Where offsetting is not suitable on divorce, pension sharing will usually be chosen over an earmarking order, since it allows a clean break for the pension.

Important Information

Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.

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