I am contemplating getting divorced from my husband and have heard a lot of talk about the sharing of his pension entitlement. What options are there for dealing with pension benefits on divorce?
There are now three distinct ways of dealing with a former spouse's pension benefits.
Under this approach, the exspouse without the pension benefits takes other assets of a comparable value. This was the only solution until the Pensions Act 1995. For offsetting to be successful, there have to be other assets to pass to the ex-spouse. In many instances, the main assets of the couple tend to be the house and the husband's pension fund.
Even if these two assets have similar values, it is not very satisfactory if one party ends up with the pension fund and the other takes the house. But where there are other substantial assets, offsetting can work well and has the advantage of creating a clean break.
The Pensions Act 1995 introduced this new solution whereby the pension administrator can be instructed to pay all or part of the pension benefits to the ex-spouse when the benefits become payable. Earmarking refers to the ability to instruct the pension scheme trustees to make a payment from the pension scheme directly to the ex-spouse. The following problems are associated with earmarking:
For tax purposes, any pension paid to the ex-spouse is treated as though it were still the scheme member's.
Retirement benefits will not be payable until the member's benefits become payable, regardless of the needs of the ex-spouse.
Pension payments will cease on the death of the member, subject to any guaranteed period that exists.
Payments to the ex-spouse will cease if they remarry.
An earmarking order in respect of a lump-sum benefit does not cease on the death or remarriage of the ex-spouse. This last point means that an earmarking order for a lump sum would still be effective if the ex-spouse predeceased the scheme member, resulting in the need to keep open the estate of the deceased ex-spouse in case a payment becomes due in the future.
A copy of the court order must be sent to the scheme trustees and they must take reasonable steps to ensure that they are paying the correct person. The ex-spouse must notify the trustees within 14 days of remarriage because earmarking is seen as a form of deferred maintenance which ceases on remarriage.
The obvious failings of earmarking led to growing pressure to permit a transfer of funds from one party to the other and the necessary legislation for this was included in the Welfare Reform and Pensions Act 1999 and the Child Support, Pensions and Social Security Act 2000.
Introduced by the Welfare Reform and Pensions Act 1999, pension sharing makes it possible to transfer all or part of the value of the pension benefits into a new contract for the ex-spouse. Pension sharing is available where the petition for divorce is filed on or after December 1, 2000. Earmarking and pension sharing cannot apply to the same pension arrangement.
From the member's standpoint, the big disadvantage is that their pension benefits are immediately reduced by the effect of the pension debit and, normally, the debit also has the effect of reducing the maximum permitted benefits for the member under an occupational scheme. This will clearly limit the scope for the member to rebuild his pension entitlement following pension sharing.
However, as a concession, a member of an occupational scheme approved under S591 of ICTA 1988 (other than a simplified defined-contribution scheme) will not have the maximum permitted benefits reduced by the debit provided:
He is not a controlling director of the company.
Pension benefits have not yet come into payment.
Taxable earnings did not exceed 25 per cent of the earnings cap in the tax year in which the divorce occurred. For this purpose, the earnings to be used are those from the employment being pensioned by the scheme in question and for the tax year immediately preceding that in which the divorce occurred.
One advantage is that this represents a clean break and removes all the uncertainty associated with deferred maintenance and any need to maintain contact with the ex-spouse. When benefits become payable, the member is taxed only on his benefits. This contrasts with the position under earmarking where all the benefits are deemed to belong to the scheme member for tax purposes.
From the ex-spouse's standpoint, the advantage is that there is a definite entitlement to pension benefits which does not depend on when the other party decides to take benefits and is not lost in the event of the other party dying first. The ex-spouse is in control of the benefits derived from the pension credit. As an extension of this, the ex-spouse is assessable to tax in the usual way for any benefits derived from the pension credit.
There will be occasions where one of the other options is more suited to the circumstances than pension sharing. For example, where the pension entitlement is relatively small, there is little point in both parties ending up with an even smaller entitlement. Offsetting will probably be the best option here.
Earmarking might produce the most satisfactory outcome if, for example, the pension is in payment and the ex-spouse is much older than the member or in poor health. The member might agree to a relatively high level of earmarking in the expectation that it will revert to the member on the death of the ex-spouse.
The needs of each party must be considered together with those of any dependants. The strengths and weaknesses of each option should then be weighed against these needs and the best solution selected. Of course, what is best for one party is not necessarily the best for the other so a compromise may be called for.