Pensions and divorce – what are the options?

The sad truth is that statistically, 42% of marriages will end in divorce.  As well as the emotional fall-out from those broken relationships, there are of course financial implications.  Dividing the family wealth, making provision for the support of any children, and ensuring that both parties are able to get back on their financial feet all feature prominently in any divorce settlement.

But while the immediate needs of each member of the family are usually front of mind, the consequences of the split for how both parties will see out their later years are often overlooked.

Alongside the family home, a couple’s pensions are generally the most valuable assets they will have, and how they are treated can be one of the most complex aspects of any divorce or dissolution settlement.

Traditionally, the value of any pension rights was simply included as a marital asset, and offset against other assets in agreeing a settlement.  So if one party had a much larger pension, then the other might take a bigger proportion of the family home to compensate.

This remains a popular solution, but it is not always appropriate, especially if the family home is needed while any children are still living at home.  So it is worth exploring two other methods for dealing with pension rights as part of a divorce settlement:

• Pension earmarking requires some of one party’s retirement and/or lump sum death benefits to be paid to the other when the holder retires or dies.  This does, of course, tie the two parties together for the long-term.

• Pension sharing is where pension rights are physically divided and some of one party’s rights are awarded to the other as their own independent pension benefits.  This option is more common nowadays as it provides a clean break between the parties.

A combination of methods can be used, but the same pension rights cannot be both shared and earmarked.

One often-asked question is how pension rights are valued so that they can be split appropriately.  Fortunately, the law is clear on this, and sets out the process.

• Pre-retirement rights, or income drawdown funds, under registered pension schemes will normally be valued based on their cash equivalent transfer value.

• Annuities or scheme pensions in payment should be valued by the provider, trustees or an actuary in line with the cash equivalent transfer value requirements.

• Rights under the earnings related element of the State Pension scheme, and any protected payment under the New State Pension, will be given a capital value by the DWP.

So which is the best way to split pensions on divorce?  This will very much depend on individual circumstances, as both the needs of each couple, and the nature of their pensions, will be different in almost every case – and each pension scheme’s policy on divorce will vary from provider to provider.  Ultimately it is up to the divorcing parties and their lawyers (and, if necessary, the Court), to decide which is the best method in each case.

Either way, both parties are likely to need professional advice following the settlement.  If a pension is being split, it may well mean that the pension-holder may need to make up any shortfall between the benefits they expected and what they will receive post-split.  And their former spouse or civil partner may need advice on pension transfer.

In the emotion-charged process of divorce, people tend to think about their immediate financial needs.  But carefully assessing and dividing any pension rights will ensure that both parties don’t lose out when they get to retirement.