‘Moving targets’ on divorce and pension sharing orders

Jones, Martin_700x450

Those aged between 40 and 49 are now the most prolific divorcers, according to the Office of National Statistics. People of this age will be dealing with larger figures in terms of personal wealth, assets and pension savings and as such it is important to get things right.

The most common method of dealing with a pension on divorce is a pension sharing order. Under a PSO, the court will order a share of a pension arrangement belonging to spouse A be transferred to spouse B. The value of the share – known as a pension credit  – is then calculated by reference to a percentage contained in the annex to the PSO.

Pension sharing is not always a swift process. The rules allow the court to carry out its valuation process up to a year before the date of petition. This is the valuation from which the percentage is initially calculated. The PSO will not come into effect until the later of the decree absolute or 28 days after the PSO is granted.

The provider may then require other documentation such as transfer paperwork and it is not uncommon for the former spouse to not even know where they want to transfer to at this stage. Finally, the provider has a four-month period in which to settle the PSO. It will need to revalue the pension scheme to calculate the value of the pension credit and can use a valuation from any date within that period.

The mechanics of this process mean the scheme administrator might not calculate the actual value of the pension credit until much further down the line, at which point it may be quite different to that used during court proceedings. This can seriously distort the value of the overall divorce settlement – an issue sometimes referred to as “moving target” syndrome. Here are some figures to illustrate the effect.

Example one: After one year.

Brad and Angelina have got divorced. Angelina is getting a share of Brad’s Sipp.

1 February 2015: Brad’s Sipp valued at £350,000.

15 December 2015: PSO for 50 per cent (£175,000) based on initial valuation.

20 December 2015: Decree absolute granted.

10 January 2016: Documents sent
to pension provider.

20 February 2016: Sipp valued
at £290,000.

26 February 2016: Transfer of £145,000 to Angelina’s pension
(50 per cent of £290,000).

In some cases, the paperwork might not be sent to the provider until several years after the  divorce, which can magnify the effect of moving target syndrome. Let’s assume Brad had made some very speculative investment choices since the initial valuation. Several years later and his Sipp has gone down to £200,000 when the pension credit is calculated. This leaves Angelina with a share of only £100,000.

What can you do to mitigate this? Historically, it was possible to draft the order so it read: “such percentage as will give effect to a pension credit of £XXXX”. This aimed to fix the pension credit at the value initially agreed on. However, thanks to the High Court case of H v H [2009] EWHC 3739 (Fam) this is no longer possible.

It therefore comes down to being as practical as possible. Firstly, aim to use a valuation from a date as close to the court proceedings as possible. This will mean any other calculations as part of the overall divorce settlement will take this more up-to-date valuation into account rather than a figure from several months previously.

Next, you should aim to get the case processed as soon as possible. The rules state PSOs must be completed within a four-month implementation period. However, rulings from the Pensions Ombudsman have made it clear providers must act as soon as they are reasonably able to. As such, it is probable the provider will want to process the PSO as soon as it can.

Depending on its own internal processes, it may also be possible to ask the provider to use a valuation towards the beginning of the implementation period.

If you are advising the former spouse, it may be prudent to arrive at a plan early on in terms of where to transfer the pension share. If you are advising the member, the former spouse’s plans may or may not be under your control. That said, you can still consider whether it is appropriate to switch some or all investments into a less volatile asset class.

Example two: Reduce the delay.

Let’s take another look at the figures. In this situation, Brad’s adviser obtains a valuation a couple of weeks before the court proceedings.

20 November 2015: Brad’s Sipp valued at £300,000.

15 December 2015: PSO for 50 per cent (£150,000) based on initial valuation.

20 December 2015: Decree absolute granted.

10 January 2016: Documents sent
to provider.

20 February 2016: Sipp valued at £290,000.

26 February 2016: Transfer of £145,000 to Angelina’s pension
(50 per cent of £290,000).

In this scenario, Angelina has still only received £145,000. However, the other cash and property rights transferred into her name as part of the settlement will take this lower figure into account. Overall, Angelina receives what she was expecting and what the two parties had agreed on.

Example three: Scotland.

It is worth noting PSOs operate slightly differently in Scotland. Under Scottish law, the pension credit can be expressed in the order as a monetary amount. This means the former spouse will get the same figure at implementation as agreed at the outset. While this delivers certainty for the former spouse, the member takes on all of the risk for any fund value fluctuations, which some might perceive to be unfair.

Let’s imagine Brad and Angelina had moved to Scotland several years previously.

1 February 2015: Brad’s Sipp valued at £350,000.

15 December 2015: PSO for 50 per cent (£175,000) based on initial valuation.

20 December 2015: Decree of divorce granted.

10 January 2016: Documents
sent to provider.

20 February 2016: Sipp valued
at £290,000.

26 February 2016: Transfer of £175,000 to Angelina’s pension

Angelina has received the £175,000 she was expecting at the outset. However, Brad’s fund value has dipped and the end result is that he has lost 60 per cent of his Sipp rather than 50 per cent.

Overall, a PSO is a blunt instrument that sometimes struggles to cope with the nuances and complexities of modern retirement products. However, as with many areas of financial planning, it is an area where a little bit of knowledge can go a long way to ensuring an equitable and predictable outcome is delivered for both parties.

Martin Jones is technical resources consultant at AJ Bell