Divorce is not only an emotionally but also financially fraught experience. Of the assets that must be considered, pensions are one of the most important, yet often ignored. Pensions can make up as much as half a husband and wife’s income in the UK, sometimes more than their home. Know how pensions work in a divorce is important to negotiating a settlement that’s equitable for both spouses and helps to maintain the long-term viability of the marriage.
How Pensions Can Impact Divorce Settlements.
Pensions are typically the second largest asset after the home. They are supposed to support you in retirement and, when you get divorced, their value will need to be considered alongside other assets like property, savings, and investments. In the UK, pensions form part of the marital pot and therefore their value can be split no matter which spouse received them.
Refusing pensions in divorce cases can have devastating implications for the husband or wife who may have given up work or earnings opportunities to raise children or run the house. If not properly divided, this spouse could struggle financially when it comes time to retire.
How Pensions Are Valued
It is important to first determine the value of pensions in order to divide them in a divorce. This is generally accomplished by getting a CETV from the pension fund. The CETV is the percentage that will be converted if the pension is transferred to another scheme. However, this value doesn’t necessarily reflect the actual value of the pension, especially in defined benefit schemes that provide a guaranteed lifetime income. Professional advice is the key to understanding how much the pension really amounts to.
Moreover, pension allocation should take account of future productivity and spouses’ age. An older spouse, for instance, might have more time to build up pension assets, whereas an older one will be more dependent on his or her pension share.
Methods of Pension Division
Pension sharing, pension offsetting and pension earmarking are the three main ways in which UK couples split pensions during a divorce.
Pension Sharing
Pension sharing is the most prevalent approach, and it involves dividing the pension into two pots. This is the way in which both parties retain control over their share, and make their own decisions regarding their retirement funds. The court issues a pension sharing order, defining how much of the pension should be shifted. When the process is complete, the recipient spouse can move his/her portion to his pension account.
Pension Offsetting
Pension offsetting lets one spouse maintain a full pension while the other receives assets of equal worth. For instance, one spouse could keep his pension and the other a larger proportion of the family home or bank accounts. Although this avoids the difficulties of disaggregating the pension in its own right, it isn’t straightforward to make it fair, especially as pensions are typically long-term.
Pension Earmarking
Known as a pension attachment order, earmarking assigns a portion of one spouse’s pension to the other at retirement. This option is less common, however, because it entrusts the receiving spouse’s economic future to the pension holder’s choices and disposition. Further, the pensioner could die before the earmarked portion is paid.
Tax Implications
It’s important to know the tax implications of dividing pensions. Pension sharing, for instance, means that the share you’ve transferred becomes a new pension to the receiving spouse, and is subject to standard taxation when you withdraw it. Pension earmarking contributions, by contrast, are subject to income taxation for the original owner, which can lead to unintended consequences.
To help make sense of these nuanced elements and to be on the safe side, it’s wise to talk to a financial advisor or pension professional.
Ensuring Fairness in Pension Settlements
Creating equality in pension allocation takes a multifaceted approach. The division will take into account not only the value of the pension but its type, its investment potential and its relationship to the overall settlement. Courts in the UK abide by the principle of equality, but cases are judged on an individual basis depending on the length of the marriage, the demands of the couple, and their contribution.
In the case of couples who have substantial pension balances, an employer can hire a pension actuary to give valuable advice on how much the pension actually pays and if the split should be equitable. And women, in particular, should be extra careful because they are statistically more likely to lose pension rights if they are divorced.
The Importance of Professional Advice
Divorce settlements involving pensions should be handled by professionals. Family lawyers, financial advisers and pension advisors can provide specialist advice to make sure you get what you deserve. The Pension Advisory Service and Resolution also provide tools to help you know your rights and choices.
Planning for the Future
Splitting pensions in a divorce isn’t just about the present, but also about a secure financial future for both spouses. When couples approach pensions as they would any other asset, they can establish a solid foundation for financial independence and retirement security.
Understanding the impact of pensions on divorce settlements is a key consideration. With the right information and expert advice, you can overcome this difficult situation and still bring a just and equitable outcome.
