Pensions and divorce

This article provides a very brief overview of the different methods of dealing with pensions on divorce.

Pensions are often one of the most valuable assets individuals have. They are considered marital assets (with the exception of most State Pensions) and are subject to division during divorce proceedings. Both parties are required to disclose their pension details, and a court will consider them when making a financial settlement.

The rules and procedures for pensions on divorce differ between Scottish law and the laws in England and Wales. Northern Irish legislation effectively mirrors the position in England and Wales. For example, in Scotland the matrimonial property includes all assets acquired by either party between the date of marriage and the date of separation. Whereas in England and Wales assets accrued before marriage and after separation can be included.

There are three methods of taking pensions into account, known as: offsetting, pension sharing, and earmarking.

1. Offsetting

Offsetting involves balancing the value of the pension against other matrimonial assets. One party may keep their pension while the other party receives a larger share, or even all, of another asset, such as the family home.

2. Earmarking

This method ‘earmarks’ some or all of the pension income and/or lump sums to be paid to the ex-spouse at a certain point. In effect it is a payment mechanism and doesn’t change the ownership of the pension benefits. This means that lump sums must be tested and will be tested against the member’s lump sum and/or lump sum and death benefit allowance rather than the ex-spouse’s. It also means that earmarked income that is paid out is taxed against the member even though it is the former partner that receives it.

Pension income

Pension income can be earmarked in England, Wales (and Northern Ireland), but not in Scotland. A survivor’s pension can’t be earmarked in any of the countries. An earmarking on pension income ceases upon the death of either party or upon remarriage of the ex-spouse.

Lump sums

Lump sums (tax-free cash) on retirement and on death can be earmarked throughout the UK. The earmarking does not automatically cease upon death of either party, but it is possible for the order to be written such that it does.

3. Pension Sharing

Pension sharing means that a member’s pension rights are split at the time of divorce and secured in a pension in the ex-spouses/ex-partners name. In England, Wales, and Northern Ireland, a percentage of the pension rights within the agreed schemes are shared, whereas in Scotland it can be a monetary value or a percentage of the pension rights within the agreed schemes that are shared.

The agreed percentage/monetary value that is deducted from the member’s pension is called a debit and the new pension rights for the ex-spouse is called a pension credit. The scheme implementing the pension share will either offer the ex-spouse membership in the existing scheme or allow a transfer out to a new pension scheme.

Where the pension share applies to pension rights that have already come into payment, the transfer to the ex-spouse is called a disqualifying pension credit. Once in the ex-spouse’s name, this will become uncrystallised rights, but no tax-free will be available from this money or the growth on it. This is because tax-free cash is deemed to have been taken by the member.

4. Further implications to consider

Pension orders made by foreign courts are not recognised and will not be implemented by UK pension schemes. A UK order will need to be obtained.

Pension Protection Fund (PPF) compensation can be shared via a compensation sharing order or earmarked. If a compensation sharing order is made, the ex-spouse will be provided with compensation credit benefits within the PPF. There is no option for the ex-spouse to transfer their compensation credit to another arrangement.

Before an earmarking order is made it must be approved by the pension scheme as acceptable and capable of implementation. A scheme can object.

A member may transfer pension benefits subject to an earmarking order. However, not all pension schemes will accept transfers with earmarked benefits. Quilter’s Collective Retirement Account will not.