Over the last couple of weeks we have been looking at the impending introduction of pension sharing in divorce proceedings and we ended last week's discussion by starting to look at how this will work in funded finalsalary schemes.
It should be noted, first of all, that in these (funded) schemes the person granted the award – known as pension credits – is entitled to a share of the member's transfer value. The scheme may offer an alternative of a share of the member's accrued benefits, making the spouse a member of the scheme.
However, even if the scheme makes such an offer the spouse is not obliged to accept. He or she may instead insist on a share of the transfer value.
The example we quoted was of Harold seeking a pension-sharing order against his wife, Maureen. In particular, we noted that it is too simp listic to assume the loss of, say, six years' pension benefits against Maureen would automatically mean six years' credit to Harold.
As regards the latter, the benefits of accrued years' service will grow in value over the years by the rate of growth of Maureen's salary.
If Maureen were to lose a pension debit of six years' service her loss would equate to 6/60ths of £30,000 equalling £3,000 per year, increased to retirement age by assumed salary growth of, say, 6 per cent a year which after 25 years equals about £12,000.
However, Harold's credit is £3,000 a year at the date of the settlement and, as a preserved pension, usually this will be in this type of scheme be inc reased in line with increases in the retail prices index subject to a maximum rate of increase of 5 per cent a year. This revaluation rate is technically known as limited price indexation.
So, Maureen's pension benefits are going to be increased by (ignoring major career progression) the rate of growth in national average earnings while Harold's new credits will be increased in line with increases in the RPI.
Historically, average earnings have consistently risen faster than price inflation and are expected to continue to do so for the foreseeable future.
So if we are to assume earnings' growth of 6 per cent for Maureen it would be reasonable to assume RPI growth of around 3 per cent (it does not matter, for our purposes of illustration what the assumed RPI number is – simply that we acknowledge it should be lower than 6 per cent).
The pension credit to Harold, therefore, equates to 6/60ths of £30,000 equal to £3,000 a year, inc reased to ret irement age assumed rate of growth in the RPI, say, 3 per cent per year equal (after 25 years) to about £6,000 a year.
If, therefore, Maureen were to lose six years' service as a debit, we could project (as above) that this would mean £12,000 a year loss of pension at retirement, even though her former husband gained only £6,000 a year benefit.
This would result in a significant profit to final-salary pension schemes on each pension-sharing order.
While we have already noted that the regulations have been set so as not to work to the financial detriment of schemes served with a pension-sharing order, it is also the case that they cannot be financially beneficial to the schemes either.
So, in fact, while Harold does indeed receive his pension credit as outlined above (that is, six =years' service as a preserved pension), Maureen does not lose six years' service as a debit.
What actually happens is that Maureen's pension will be calculated first as if no sharing order has been made aga inst it but this is then reduced by the actual even tual amount of the payment to Harold.
This is perhaps best illustrated by continuing our example. Let us assume that our assumption of future RPI, for Harold's credits, has proven correct and that, therefore, his sharing order turns out to be worth £6,000 a year as a pension for the remainder of his life.
Let us then assume that Maureen's eventual ben efits for the full period of her service transpires to be £35,000 a year.
This, then, means that the net pension remaining pay able to Maureen will be:
Full pension £35,000
to Harold £6,000
to Maureen £29,000
It is useful to note that if Maureen had lost six years' service, the shared pension debit would have been – as outlined above – £12,000 and therefore Maureen would have been £6,000 worse off.
We have so far looked at the valuation methodology where the spouse's benefits are retained in the member's pension scheme.
at if the spouse seeks to transfer his benefit share out of the scheme?
Again continuing our example of Harold and Maur een, the value of Harold's pension share if taken as a transfer (if, indeed, such an option is available) would be 30 per cent of Maureen's transfer value, as calculated and provided by the scheme.
This transfer value was referred to in relation to pension earmarking orders as the cash equivalent transfer value but in more recent regulations is referred to more simply, and sensibly, as the cash equivalent.
What it means is that the spouse will have secured a percentage of the transfer value, calculated by the sch eme, on the basis that Maur een had left service on the date of the sharing order.
Simply, then, the value of the pension credits awarded to Harold becomes 30 per cent of the cash equivalent and the value of the pension debits remains just as if Harold had left the benefits in Maureen's scheme.
She, therefore, will fare no better or worse because of the transfer. Whether Harold would be well advised to effect the transfer (if, indeed, he had the choice) depends on a number of factors well known to pension transfer specialists but, due to the complex nat ure of this field of pensions, is beyond the scope of non-specialists. It may, though, be useful to note three points in particular about the level of the transfer value.
There is rarely any all owance for death-in-service benefit.
There will almost invariably be an allowance for a spouse's pension and the value will be based on the member's age and term to retirement.
It may be advisable for a spouse who is awarded a share of the member's pension also to seek an award in respect of the death-in-service benefit.
Pension sharing looks set to be popular with divorce lawyers and judges, certainly in preference to earmarking orders, which have never really taken off and are never likely to do so after the reasoning of the judge's opinion in the case of T versus T.
However, at the time of writing, it appears highly unlikely that pension-sharing orders will, at least in the short term, be preferred by courts over set-off arrangements.
We boldly predict, however, that, against all expectations, pension sharing will, within the next decade, become the accepted strategy by which pension claims will be satisfied.
Solicitors and the courts will realise that they should not be treated as a future source of income but as a current asset which should accordingly be considered capable, and even desirable, of sharing at the time of divorce.