Simon Thomas
Posted on 22 Sep 2017

Pensions on Divorce - Part 2

In part 1 we covered, in outline, the various ways in which inequalities in the value of pension savings held by each party to a divorce financial settlement could be resolved.

Offsetting

Where there is an imbalance in the value of the pension savings belonging to each party and that imbalance would not be fair in the overall settlement of finances, one  party transfers other assets (unrelated to pensions) to the other so that the total value of savings, pensions and otherwise, is equalised or at least brought closer together.

This solution has the advantage of simplicity and is relatively economical to achieve. However there are problems. For example, one party might transfer his share in the former joint home to the other to make up for differences in the value of their respective pensions. That might create something nearer to mathematical equality and it certainly would provide somewhere for the party receiving the house to live. What it certainly does not do is to provide a pension in later life.

If the party who receives the house is also dependent on maintenance, that support could stop if the paying party dies or becomes unemployed. The receiving party could then well face having to move house later in life and furthermore might not have sufficient funds to find small accommodation as well as a reasonable pension.

Pension sharing

In this case, there is a valuation taken of the pensions available to both parties. That total value is that split (shared) between the two parties in whatever proportions is agreed or ordered by the court. That split might given for example, each party 50 per cent of the total value of the pension savings: alternatively, there could be a sharing of, say, 40/60 or 30/70.

When the splitting has been established, the receiving party sets up a pension fund or uses an existing fund and the agreed share is transferred in. Each party then has their own pension in their own name and the other party has no claim on that pension in the future.

Earmarking

Under this arrangement, the whole pension continues to belong to the party in whose name it is. However that pension owning party, by agreement or court order, is required to pay to the other party, a proportion of the tax-free capital and/or pension income.

There are two significant disadvantages to this arrangement to the person receiving the payments. The first is that so far as annuity payments are concerned, they are taxed in the hands of the receiving party at the marginal rate of the pension owning party. This means that, even if the receiving party has no other income and therefore has a marginal tax rate of 20%, if the pension owning party has a marginal rate of say 40%, the receiving party has to bear tax at that higher rate.

The second disadvantage is that if the pension owning party does, then the pension ceases. The consequence is that the receiving party will have no further payments from the pension.

For these reasons, earmarking is rarely used. It might only be suitable in cases, for example, where the receiving party has a very short life expectancy because of a serious illness.

State pension

Two final comments relate to the state pension.

The state pension cannot be shared or split. It should be borne in mind, however, that a party who does not have a record of full national insurance payments, might be able to claim a higher state pension based on their partner’s record of contributions.

Secondly, although the state pension cannot itself be split, it might be possible to use “offsetting” (see above) by transferring additional assets to the party with the lower state pension.

It can be seen that the whole issue of pensions on divorce is complex, not least on making wise choices as to the best solution depending on the circumstances in each case. One danger is that the wrong solution could have serious financial consequences in retirement for one or even both of the parties.

For more information or some preliminary, confidential advice, please contact Simon Thomas, Head of the Family Team by telephone +44 (0)1392 687630 or by email simon.thomas@michelmores.com