Over the last few weeks, we have been examining and detailing the workings of the newly introduced pension-sharing orders in divorce proceedings.
A number of financial services commentators and journalists seem to assume that these sharing orders will become the only method of dividing the value of pension rights, totally ignoring the likelihood that the traditional method employed by solicitors and the courts – set-off – is widely predicted to remain the favoured route among divorce practitioners.
We look closer at this method of settlement next week when we bring this series to a close by summarising the opportunities for pension consultants to become profitably involved in this area of advice.
First this week, we look at the remaining method of dividing the value of pension rights in divorce – earmarking orders – and in particular discuss why they have been compar atively almost totally ignored by divorce lawyers and judges since their introduction in 1996.
With more of a whisper than a bang, earmarking was introduced in 1996 as a method of settling the claims, during divorce proceedings, of one spouse against the value of the other spouse's accumulated pension rights.
No longer must the claim fail if the pension scheme member has few, if any, non-pension assets (as was previously the case under set-off, as we shall discuss next week). Now we have an alternative to setting off the value of a pension claim against other assets.
The Matrimonial Causes Act 1973 s25(2)(h) gave specific mention of pension benefits as an example of a benefit which one spouse might lose the chance of acquiring on becoming divorced and therefore should be considered by the courts in arriving at a financial settlement.
The Pensions Act 1995 deleted the words “for example, a pension” from this subsection, inserting into the 1973 act new subsections 25B, 25C and 25D, thus giving claiming in respect of pension rights much more prominence.
Matrimonial Causes Act 1973 s25(2)(a) requires the court to have regard to the income, earnings capacity, property and other financial res ources which each of the parties to the marriage has or is likely to have in the foreseeable future.
Many divorce practitioners used this as a defence of a client's pension rights where the pension was not likely to become payable for at least five years. As noted earlier, the Pensions Act 1995 ins erted a new s25B relating specifically to pension rights, with s25B(1)(a) confirming that, as regards pension rights, the effect of s25(2)(a) and other s25(2) subsections shall be as if the words “in the foreseeable future” were omitted.
In other words, the 1995 amendment confirms that a spouse's future pension rights should be taken into account in financial settlements no matter how far in the future they are due to come into payment. The courts should now have regard to accrued pension rights even of very young divorcing spouses.
It is possible that this deletion of the words “in the foreseeable future” could well have a significant practical impact on the valuation and consideration of pension rights. However, for the courts (or, more frequently, the spouses' legal advisers) to be able to have regard to a spouse's future pension income for these purposes, there must be a reasonable and accurate projection of the value of that income. Meaningful valuation of pension rights is essential.
Most importantly, the Pensions Act has enabled earmarking orders (sometimes known as attachment orders) to be made by the courts.
In Scotland, these can only take the form of earmarked lump-sum orders but in the rest of the UK, the courts may make either earmarked lump-sum orders or earmarked periodic payment orders or a combination of both.
Earmarked lump-sum orders
Here, the order is made at the point of the financial settlement in a divorce case but no money or value changes hands at that time. Instead, the order is served on the pension scheme member, who must then direct a specified lump sum out of the pension scheme to the former spouse when the pension scheme member starts to take his or her benefits usually at retirement (although not necessarily, of course, for example, with personal pensions).
The amount of lump sum paid by the scheme to the former spouse reduces the lump sum payable to the scheme member. For Example:
Fred and Joanne divorce at the age of 47. Among other aspects of the financial settlement, Fred is awarded an earmarked lump-sum order against Joanne's final-salary pension scheme benefits to the amount of £15,000. When Joanne retires and starts to draw her pension benefits, her tax-free cash entitlement is £60,000. Her scheme, having been served with the earmarked order, must now pay £15,000 of that lump sum to Fred, leaving the remaining £45,000 to be paid to Joanne.
Although in the above example the earmarked order was expressed in cash terms, it is alternatively possible to express the order as a percentage of benefits (for example, Fred to be awarded, say, 30 per cent of Joanne's tax-free lump sum). Indeed, since December 1, orders must now be expressed in percentage terms.
Earmarked periodic payment orders
Here again, the order is made at the point of the financial settlement in a divorce case but no money or value changes hands at that time. Instead, the order is served on the pension scheme member who must then direct a specified regular payment to the former spouse from the time the pension scheme member starts to take his or her benefits.
The amount of regular payment (“pension”) paid by the scheme to the former spouse reduces the residual pension payable to the scheme member in a similar way to the above lump-sum example. As with earmarked lump-sum orders, these periodic payment orders may in the past have been expressed in cash or in percentage terms but, since December 1, must now be expressed in percentage terms.
Death of either spouse after the making of an earmarking order Should either spouse die after the making of an earmarking order, then an earmarked periodic payment order comes to an end although an earmarked lump-sum order remains payable.
If a claimant spouse secures an earmarked periodic payment order, therefore, he or she should strongly consider the merits of effecting life insurance on the pension scheme member to cover the potential loss.
Remarriage of the spouse
If the spouse, that is, the person in whose favour an earmarked order has been made, remarries (or, in many cases, even if he or she cohabits), then an earmarked periodic payment order comes to an end although an earmarked lumpsum order survives.
A major issue in the making of earmarked orders remains valuation. Agreement has to be reached on many aspects of this issue, not least the age at which retirement may be predicated, assumed rate of growth up to that time and the spouse's share of the member's benefits. Detail relating to this is beyond the scope of this article, which is designed to discuss the overall picture.
Earmarked orders – summary of issues
It has been suggested that supporters of pensions and divorce reform “won the battle but lost the war” by accepting the concept of earmarking orders as, although earmarking orders might appear to be valuable, they could prove worthless on the death of either party or the remarriage of the spouse.
In this realisation, the reformists turned their attention to pressing for further legislation, permitting the introduction of pension-splitting, now becoming more commonly known as pension sharing, as we have been discussing over the last few weeks.
Keith Popplewell is managing director of Professional Briefing