Pensions and Divorce
Pension Sharing is available where divorce or nullity proceedings commence after 1/12/2000 in England and Wales the date on which the petition is lodged with the court, in Scotland the date of service of the summons. PS orders cannot take effect until the decree has become absolute - any appeal will therefore cause delay until at least 7 days after the end of the period for filing notice of the appeal.
In connection with divorce situations pension advice will be required at various stages. Firstly, whether your client is the prospective "debit spouse" or "credit spouse" advice will require to be given on the implications of each option i.e. offsetting, earmarking and pension sharing. Due to the many different types of pension arrangement and the fact that the implications will be different depending on the type involved in each case, combined with the fact that each client's financial circumstances will be unique to their own situation, in many cases this preliminary advice will require to be "client specific". In order to obtain the best value from such advice it will usually be best to provide some generic information in advance which should include a "jargon buster" such as that provided on our own website.
In considering the "sharing" option, for example, it will be necessary to establish whether the potential debit scheme offers internal and/or external transfer options for the credit spouse and, if so, whether an external transfer is likely to be more favourable. Initially it is only important that client's understand the concepts of internal and external transfers. Ultimately this type of analysis will require detailed calculations but these are not worth undertaking at this early stage. Nevertheless your client should have a clear understanding of the general implications.
After the divorce the debited spouse will require advice to resolve the problems created by the depletion of his/her pension benefits. This would include quantifying the client's financial objectives in retirement, and calculating how much additional savings are required to achieve this objective. The effects of Inland Revenue limits on maximum contributions or benefits may mean that the client's objectives cannot be fully achieved through additional pension saving and consideration will therefore also need to be given to alternative savings vehicles such as Individual Savings Accounts.
For the credit spouse advice will be required in more complex matters. In some circumstances the pension credit can be held in the former spouse's scheme and this may or may not be of benefit. This is known as "shadow membership". Equally, where the credit spouse is already a member of a pension scheme then, in addition to the possibility of "shadow membership", the option of transferring the pension credit to their existing scheme will also need to be considered. There are also various alternative forms of individual pension arrangement and, in the selection of the most appropriate vehicle for receiving the pension credit, if this is an individual pension plan, then further advice will be required regarding the type of individual pension plan and how the fund should be invested within the plan. In considering the most appropriate arrangement account will be need to be taken of the effects of Inland Revenue limits which differ according to the type of plan selected. In analysing these various options the key issues to be determined will be the implications in relation to (a) the ultimate pension benefits (b) death benefits (before and after retirement) and (c) the level of prospective tax free cash entitlement. In most cases it is likely that the credit spouse will naturally wish to transfer the pension credit either to an existing pension scheme or an individual plan of which there are various types available. This has the obvious attraction of giving them more control over the investment of the fund. However it should be borne in mind that pension credits can only be transferred from funded schemes i.e. those where the benefits are on a "money purchase" basis or in the form of a benefit promise (defined benefits scheme) for which there is a fund accumulated to match the defined benefit liabilities. Most private sector schemes are funded while many public sector schemes are unfunded i.e. the liability is a debt on the employer and not matched by assets held separately from the employer. Accordingly, the only option where the pension benefits of the "debit spouse" are held in an unfunded scheme is for the "credit spouse" to become a "shadow member" of that scheme. Shadow membership confers the same rights on the individual as generally apply to full members who have left service i.e. they will have an individual "paid up" benefit entitlement which they can elect to take at any time subject to the scheme rules. The form of the benefits in terms of tax free cash, annual pension increases etc will follow that of the scheme generally. It therefore follows that when a pension sharing order is issued in relation to benefits arising under an unfunded scheme the only advice that the credit spouse will require is in relation to the timing of those benefits and the extent (if any) to which the benefits need to be supplemented by an additional savings.
Where the sharing order is in respect of a funded scheme there may or may not be an option for "shadow membership" depending on the scheme rules. In many cases the administrative difficulties of tracking pension credits have resulted in schemes not permitting shadow membership. Where it is an option then the potential merits of scheme membership need to be weighed against the alternative potential benefits of transferring the credit to an individual arrangement or (where relevant) the existing scheme of the credit spouse. As indicated above there are various forms of individual pension arrangement and the legislation permits the transfer of pension credits to any approved arrangement with some minor exceptions. The choice of arrangement may in some cases be of particular importance as there are different Inland Revenue benefit limits that apply to different forms of arrangement.
Generally once the pension credit has been transferred the benefits can be taken at any age between 50 and 75 except that part of the benefits which relates to the former spouse's "contracted" entitlement (i.e. where the scheme or policy from which the benefits arose was contracted out of the State Earnings Related Pension Scheme) in which case these become known as "safeguarded rights" and must be taken between age 60 and 65.
Where "shadow membership" is an option and the scheme is a "defined benefit scheme" (i.e. one that provides a benefit "promise" that is defined in advance and subjected to a revaluation until retirement) then a detailed calculation of the growth rate required to match the defined benefits will be required in order to establish whether transferring the credit to an individual pension plan will be a more or less appropriate option. However other factors also need to be taken into account such as the death benefit position and the proportion of benefits available as tax free cash. This area of advice is particularly complicated and will fall within the restrictions that apply to pension transfer advice already in existence.
Where the credit spouse is already a member of a "defined benefit" scheme (and there is an option to transfer the pension credit from the ex spouse's scheme) then advice will similarly be required to establish what level of benefits could be secured under the credit spouse's existing pension in the form of defined benefit to be revalued up to retirement. Having established the level of defined benefit that can be secured the same detailed calculations require to be carried out to establish what rate of return would be necessary under an individual pension plan to match those benefits.
In either of the above two cases the growth rate so calculated (the "critical yield") needs to be assessed in relation to the client's age, attitude to investment risk and the extent to which they are dependent on the pension benefits. The closer the client is to retirement (or the dates on which they intend to take benefits) then generally the lower is the investment risk they can afford to take. However some individuals are more risk tolerant than others and so the individuals own attitude to risk must be taken into account as well. Lastly an assessment of the degree to which they are dependent on the pension benefits would be appropriate. For example where the pension represents a relatively small proportion of the divorce settlement and/or the credit spouse already has significant assets in his/her own right then adopting a higher investment risk may be appropriate.
Having carried out a formal risk assessment the advice may be further refined by carrying out "sensitivity analysis" to indicate the relative impact of failing to achieve the growth rate required. This is related to the dependency level but also takes account of the client's financial needs i.e. the relative impact is significantly higher for those who are heavily dependent on the pension whether by virtue of a lack of other resources or their income needs relative to the benefits available. A view then requires to be taken as to whether (taking all these factors into account) it is more or less likely that an individual transfer plan will achieve an improvement in benefits.
However the assessment requires to be qualitative as well as quantitative. For example, individual pension arrangements may offer significantly greater flexibility and/or higher death benefits or tax free cash at retirement. The qualitative assessment requires a detailed understanding of the provisions that apply to pension credits on transfer to individual money purchase arrangements that operate under occupational scheme limits and the different provisions applying to transfers to Personal Pension Plans.
Intelligent Pensions provides specialist advice in divorce cases and will set up and manage suitable vehicles for credit spouses to hold their pension share up to and into retirement (subject to a minimum transfer value of £50,000 excluding "Safeguarded Rights". As with all our services we take full compliance responsibility and introducing IFAs receive and retain all commissions on the benefits transferred.