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Case Study: Witness for the divorce

The problem.

I have been asked to provide an independent expert witness report for my clients who are in the process of divorcing. The husband has significant pension benefits, including final-salary schemes, and an appropriate share needs to be calculated. What information do I need and what assumptions should I use?

The solution
If both are entitled to a full basic state pension, this could be ignored for the purposes of the report but any Serps/S2P should be taken into account and a state pension forecast for each party would be preferable.

My understanding is the Department for Work and Pensions tends to expect any sharing of additional state pension to be dealt with by adjustment of the sharing order for occupational or private pensions.

For each final-salary pension scheme the cash equivalent transfer value is required and a valuation of any money-purchase arrangements is also required.

You would need to assume the CETVs and policy values will remain the same at the point of implementation. In practice, the CETVs and policy values will be recalculated at the point of implementation and any figures would be subject to change.

In respect of any money-purchase plans, it would be prudent to confirm whether there are guaranteed annuity rates, guaranteed growth rates or transfer penalties applicable.
This could affect the decision on which pension plans are shared with the spouse.

You would need to know the target retirement age for each individual and confirmation of health and smoker status as this could affect annuity rates.

You need to know whether you are targeting equalisation of income in retirement or an alternative split.

The annuity rates used will be current rates and it will be assumed that annuity rates remain constant through to the date of annuity purchases. It is unlikely annuity rates will remain static in practice.

I would point out that annuity rates are due to be equalised for men and women from December 21, 2012 following the European Court of Justice ruling.

You need to decide on an annuity basis and I tend to favour a single-life annuity, increasing by RPI and with a five-year guarantee. This reflects the benefit typically available from a final- salary scheme but without provision for a surviving spouse’s pension.

These can be sourced from the FSA market comparison annuity tables.

We will outline in the report an overview of the options available for taking an income at retirement and that annuity purchase is not the only option. For each scheme, the options available on divorce will need to be clarified. For example, whether the final-salary scheme offers shadow membership (internal share) or if the only option is to transfer away to a private pension (external share).

Some overseas schemes may not allow pension-sharing and this would need to be taken into consideration.

We will point out there are other ways of funding retirement income as well as pensions, such as investments, the home, an inheritance or part- time work.

Once all this information has been obtained, we can calculate the split of the CETV to provide the required split of income based on the respective standard, current annuity rates. We will assume both parties will be subject to the same rate of tax in retirement.

After the required split has been calculated, we will need to consider how this can be implemented.

It may be preferable for the spouse to become a shadow member of a final-salary scheme as this would entail less risk for them, both investment and annuity rate risk, and is likely to give a guaranteed, inflation linked income in retirement, although this may not be appropriate if the spouse has to wait until the member takes benefits before they can take benefits.

Shelley McCarthy is a senior paraplanner at Informed Choice

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Comments

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  1. A few coments, firstly, individuals who retire further into the future are expected to exhibit lighter mortality rates than those assumed in pricing current annuities, so if comparining income from a DC arrangement with a DB arrangement then allowance for this should be made in illustrating income from the DC arrangement.
    Secondly, one of the most important assumptions which you didn’t mention is the assumed rate of investment return for DC schemes, if comparing with income from a DB scheme, should you allow for investment in lowest risk investment?, or what level of isk to you factor in?
    Thirdly, if the spouse is permitted to retain Pension Credit benefits within a DB scheme then, he or she will be entitled to draw those benefits when they reach the scheme retirement age and may be able to draw the benefits early depending on the scheme rules. The spouse will not have to wait until the member retires as Pension Sharing provides a clean break and from the scheme perspective, once the Pension Share is implemented, they are two independent members.

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