This week, I am returning to a subject which I addressed some years ago, since when there have been significant and important developments about which I believe financial advisers must be aware. The subject is pensions and divorce.
I will start by going back to basics. The question of a divorced person’s rights to benefit from the pension earned by their former marriage partner has been contentious for many years.
Until a decade or so ago, there was only one method of arriving at an agreement, known as set-off. From 1996, the introduction of earmarking orders, now more usually known as attachment orders, provided a former spouse with a ringfenced share of eventual pension rights.
However, activists pushing for reform of the rights of former spouses required a system which provided the benefits of a clean break.
Attachment orders suffered a disadvantage in this respect as the eventual value of any award made to a pension scheme member’s former spouse depended to a large extent on whether or not either of the former spouses died before the award came into payment.
Acknowledging the shortcomings of attachment orders and accepting the restrictions of set-off – for example, where one of the divorcing spouses has substantial pension rights but few assets outside the pension scheme – the Government introduced the option of pension sharing, initially termed pension splitting, in the Welfare Reform and Pensions Act 1999.
It is important to note that pension sharing has still not replaced either set-off or attachment orders as a method of dividing the value of pension rights in divorce proceedings. The three options are available to divorcing couples and their divorce lawyers.
The subsequent developments are therefore important to all divorcing couples where at least one of the partners has accrued rights within a pension scheme. They are also important to professional advisers during divorce proceedings. These advisers might include financial advisers and accountants, as the value of a proprietor’s business might also feature in divorce negotiations, but the key advisers are the lawyers for each spouse.
As I have mentioned above, there are now three options available to spouses in taking the value of pension rights into account in arriving at an overall divorce settlement. Each has potential advantages and disadvantages for either the pension scheme member or the spouse and it is vital to all concerned that the implications of each option is understood and taken into account in arriving at a fair eventual solution.
Pension sharing, known widely as pension splitting, has been the method preferred by campaigners for reform over the last couple of decades.
The introduction of earmarking or attachment orders in the Pension Act 1995 was a compromise between a Government which wanted more time to discuss the various propositions and the reform pressure groups which considered they had waited long enough. Winning the availability of earmarking orders was always equated in the minds of the reformists as winning a battle but not the war as they quickly understood the shortcomings of these orders.
So, even before the ink was dry on the 1995 act, pressure was mounting for further discussion towards pension sharing. A new Government pledged its support for the rapid introduction of legislation and regulations but these still suffered unforeseen delays until pension-sharing legislation was finally enacted as part of the Welfare Reform and Pensions Act 1999.
In the early period following this new legislation, it was particularly important to note that the availability of a settlement involving pensionsharing orders applied only to divorces petitioned for or after December 1, 2000. Divorce proceedings started before that date could deal with a claim against the value of accrued pension rights only by set-off or earmarking orders.
Today, it is crucial to remain aware that where the pension-sharing solution is available – nowadays in almost every divorce settlement except the very rare few which have not been settled since a partition many years ago – it is only one of the three possible methods of compensating the scheme member’s spouse. Set-off and earmarking orders remain available.
You should therefore understand the implications of having these three alternative methods available. The two parties must agree on the methodology and the numbers (the latter more properly called the quantum of the claim) to avoid the financial deal having to be referred to and settled by the court. If the two sides cannot agree on the methodology or amounts of the claim, then the dispute will involve much greater expense to both divorcing spouses.
Do not forget that the most common historical defence by a pension scheme member to any attack on the value of their accrued benefits has been, first of all, to attempt to deny completely that any value is to be passed on to the spouse.
This defence is, at least in theory, much less viable nowadays although there remain a few divorce practitioners and courts which would rather continue to take into account the value of pension rights with relative impunity compared with a divorcing couple’s other assets and income.
The 1999 act was followed by a number of regulations which filled in the details behind the principles outlined in the legislation. Readers who may want to study or refer to the detailed rules of either earmarking orders should be forewarned. The legislation introducing these two developments gives little detail about their practical workings and so, for the most part, this detail is produced pursuant to the legislation generally by statutory instruments.
These articles therefore concentrate on the practical effect of the overall impact of the legislation and supporting documents rather than the detailed regulations, much of which deals with divorce practitioner and court procedures which are not the main concern of these articles.
It is worth noting that it was and still is possible for a claim against pension rights to be settled partly by set-off and partly by earmarking orders. For example, the couple could agree to transfer £20,000 of non-pension assets to the member’s spouse alongside an agreement of an earmarked periodic payment order and/or lump sum order.
The introduction of pension-sharing orders, while permitting a mix with set-off, has not permitted a mix with earmarking with regard to the same pension scheme, remembering that an individual might have benefits with more than one pension scheme, each of which is capable of different orders in divorce proceedings.
With a little thought, you can perhaps see why attempts at mixing these two types of pension order could not work in practice. A summary of the situation is given in the table (below left).
To conclude this week’s article and set the scene for my future thoughts on the ways in which financial advisers can be of immense practical and financial assistance to clients and divorce lawyers, I will quite simply, at least in concept, remind ourselves of the way in which pension sharing works in outline.
A pension-sharing order divides a scheme member’s pension rights at the time of divorce from within the pension scheme itself. In theory, this should be the least technical and cleanest method of dividing the value of the pension claim. However, even with the best intentions, legislators and other official bodies have had to struggle hard to overcome innumerable hurdles. The following articles will explain the problems, solutions and residual questions.
Where a pension-sharing order is made, it will award an agreed proportion of the scheme member’s benefits to that person’s former spouse. Simple in theory but various nuances mean that without the help of a suitably knowledgeable financial adviser, huge mistakes can occur. More, then, in my next article.