29th September 2023
Pensions on Divorce
With the economy as it is and rising costs generally, understandably, more and more couples are choosing to sort things out between themselves when they separate, rather than taking legal advice. However, although the divorce process itself is now much simpler than it used to be, meaning that couples can usually deal with it without assistance from lawyers, people are often unaware that a divorce final order just ends the marriage, leaving financial arrangements to be finalised. Sorting out the finances is still a potentially complex exercise and as the consequences of any financial agreement can be significant, reaching a financial agreement without proper advice is never the sensible option.
One potentially crucial issue that is often not properly dealt with (or is even completely overlooked) by couples sorting out finances without advice, is pensions. So, what should couples consider when dealing with pensions? Firstly, not all pensions are the same, as there are two types of pensions: defined benefit (DB) and defined contribution (DC). The majority of pensions are DC schemes and are often referred to as money purchase schemes, as contributions are paid into the scheme by the employee or their employer. The funds are then invested and as they are therefore subject to rises and falls in the market, the amount which will ultimately be paid out by way of pension, cannot be guaranteed until the employee retires. However at any stage, the capital value (CEV) of the employee’s fund can be identified, as it is the value of the individual’s fund at that date.
DB pensions differ fundamentally from DC schemes. They are typically held by public sector employees, for example NHS workers, teachers and the police and are often referred to as final salary or career average schemes. These schemes differ from DC schemes as the sums paid on retirement are determined not by contributions, but by the employee’s salary and length of employment. As there is no individual pension pot (as there is with a DC pension), the CEV quoted for a DB pension, may not accurately reflect the value of that individual’s pension and often may significantly understate its value. This means that a couple trying to share their pensions based on the CEVs alone, may not be working on the true value of one or more of the funds and this could result in a fundamentally unfair division of the pensions.
Another trap which couples can fall into, is assuming that a pound of a pension CEV is equal in value to a pound of another asset, such as savings or even equity in a house. This is not the case, as not only should tax be taken into account, but as pensions, unlike other assets, cannot be accessed at any stage, this means that the “utility” value of a pension fund may well be significantly less than the same amount of equity or savings. Although this difference may well reduce the closer the couple is to retirement, it nevertheless should not be ignored.
Often when couples separate, one of them will have a better understanding of financial matters than the other, which leaves them vulnerable. For example, they may agree to take more equity in a house in exchange for forgoing a share in the pensions, without any real understanding of the value of what they are losing and what this might mean in the future for their retirement. It is therefore important for the less financially aware party to take advice from a lawyer and possibly from a pension expert, before making any decisions about pensions.
So, if you are going through, or considering a divorce, the moral of this tale is to find out what your options are, so that, armed with this knowledge, you can be confident that any agreement you make will not only provide you with financial security in the short term, but also in your retirement.
If you would like to find out more about pensions on divorce, or any other divorce or separation issue in order to ensure you make the right decisions for you for now and for the future, please contact our family team for a free, no obligation 30-minute consultation in either our Cranbrook or Tunbridge Wells offices on 01892 510222.