The New Year is a time when many people take stock and reassess their current situation – and whether or not they are happy in it. This could relate to a potential relocation, looking for a new job, and sometimes reviewing their relationship.
Sadly, as the financial and emotional stress of Christmas starts to take its toll, January tends to see a spike in the number of divorces that are filed for compared with the rest of the year.
What happens to pensions on divorce?
While there are obviously many things couples take into account when considering a divorce, it is highly unlikely that their pension is one of them. However, what happens to your pension on divorce is not always as simple as you may think.
There are three ways in which pensions can be dealt with when a divorce occurs:
- Offset – this is where other assets are transferred to the ex-spouse in lieu of the pension value. This is designed to give a fair overall split without touching the pension itself
- Earmarking – this is where pension income and/or tax-free cash available to the pension owner is earmarked to the ex-spouse. While the pension remains in the hands of the original owner, certain amounts are paid over to the ex-spouse as a one-off or on an on-going basis
- Pension sharing –the pension is valued and then split in an agreed manner (as per a Court Order) with a certain percentage going to the ex-spouse. Both parties will end up with a pension in their own names
All three methods have advantages and disadvantages, some of which are covered below, so careful consideration needs to be given as to the best option.
A rise in silver divorces
In recent years we have also seen a rise in the number of ‘silver divorces’. Pensions often form either the first or second (after property) most valuable asset for those in later life, and therefore careful consideration of how this should be dealt with must be given – especially when neither spouse is in employment. This can be tricky, as what might be best for one doesn’t necessarily suit the other and therefore getting a fair outcome is often difficult.
Which is the best option?
The three options laid out earlier may prove suitable depending on individual circumstances:
- Offsetting has the advantage of simplicity, but leaves one party with the pension and the other with a different type of asset. This could potentially give different outcomes for the same value of asset. For instance, one party could get the family home and the other the pension. Owning a house gives you somewhere to live but no retirement income
- Earmarking could be used to split pension income, but it will be taxed on the original recipient which may or may not be suitable. This arrangement can also cease on re-marriage and would not give any value to the ex-spouse’s estate on death. There is also the disadvantage of not giving a clean break – which will certainly be required by some divorcees
- When sharing a pension it must be valued. This is relatively simple for a defined contribution arrangement but much more difficult for a defined benefit scheme. Valuations will change depending on assumptions made by the scheme actuary, meaning that this can be a complex situation. One party will potentially get a reduced defined benefit plan while the other receives a defined contribution replacement – so it is not necessarily equitable on that basis, as one offers guarantees whilst the other is very dependent on investment returns and leaves much more exposure to risk
For those who have already retired, pensions can still be a valuable asset even if they have been turned into an income stream. Any pension in payment can still be shared, but in many cases splitting a defined benefit scheme would lead to the ex-spouse getting a defined contribution scheme in its place – which may or may not be preferential being as the same risks noted above come into play.
There are also various potential tax consequences with any of the solutions and advice should always be sought before agreeing a final outcome.
For more information on what happens to pensions when a couple divorces, speak to Tilney’s financial planners on 020 7189 2400 or by booking an initial consultation.