Pension simplification and the freedom and choice regime have changed the face of retirement so significantly the impact on areas such as divorce cannot be ignored.
Technically, we still have three options to deal with pensions in divorce settlements: offsetting, earmarking and sharing. But are they still viable in today’s environment? All have been affected in different ways by the changes of the last 10 years, so may need to be revisited.
Offsetting pensions against other assets is the easiest way to deal with them in a divorce. As it has no impact on either party’s lifetime limits or pension protections, you would have thought it might be the most preferable way to deal with things.
However, issues arise today that would not have been a problem a number of years ago. The biggest is funding pensions for the ex-spouse with little or none.
Historically, we saw annual allowance levels all the way up to £255,000 a year. This might have seemed excessive but when an ex-spouse receives a payment due to offsetting they may want to contribute as much as possible into a pension as quickly as possible. This is now restricted to £40,000, which could easily be used up.
Earmarking really should be confined to the history books. Where such orders have been put in place, replacing them with a pension sharing order should be considered.
The biggest issue with earmarking is the lack of a clean break, since the original member remains in complete control of the pension. It is possible for the ex-spouse to never receive benefits if the original member chooses not to access them. In most cases, the order will cease on death so they will not receive anything at that point either.
This is because earmarking orders just specify the amount of pension commencement lump sum or income that has to be passed to the ex-spouse when they are accessed, and not a deadline to access them.
The flexibility of income is also an issue. What the ex-spouse thought would be a regular income in retirement could well turn out to be erratic or a single lump sum taxed at the original member’s marginal rate.
On the flip side, the original member will be restricted in terms of the pension they can build, as the benefits remain theirs and are tested against their lifetime allowance, even though they should not benefit from the whole income in retirement.
The ex-spouse is able to build up funds in their own name using their own lifetime allowance irrespective of what they may receive because of the earmarking order.
Pension sharing is the more modern option and provides a clean break. However, there are still issues to be considered for both parties.
The sharing order will mean the benefits of the original member are reduced and given to the ex-spouse, which could cause lifetime allowance issues both in the short and long term.
If too much is given to the ex-spouse and they have primary protection, this could be lost. No account is taken of the growth in the fund when this is done, which skews the calculation unfairly.
The receiving ex-spouse could lose enhanced protection if the funds are put into a new arrangement in their name, so they should be transferred into an existing arrangement if this is an issue (this is quite rare but possible if both parties have significant pension benefits).
For pension sharing orders put in place after the benefits have come into payment, and provided the benefits we crystallised after A-Day, the receiving ex-spouse can apply for a lifetime allowance enhancement as they will be tested again when they start to draw benefits.
All options and their implications need to be considered when deciding on the best way to deal with pension assets in divorce.
Too often, the implications of pensions legislation are forgotten, resulting in a poor outcome for all parties.
Advice is key at a time like divorce and should not be left until after all the legal issues have been resolved.
Claire Trott is head of pensions strategy at Technical Connection
She will be joining us at Money Marketing Interactive as a speaker on May 18th.