Pensions are often one of the most significant assets in a marriage. Here’s what you need to know about pension sharing during a divorce;
Pension Sharing on Divorce: What You Need to Know
Divorce is a life-altering event, and one of the most complex issues that can arise during the process is the division of financial assets. For many couples, pensions are a significant part of their overall wealth, and understanding how pension sharing works can be crucial for both parties. If you’re going through a divorce and want to know more about pension sharing, here’s what you need to know.
1. What is Pension Sharing?
Pension sharing refers to the division of pension benefits between spouses or civil partners when they divorce or dissolve their civil partnership. In the UK, for example, pension sharing is a legally recognized method of dividing pension assets, ensuring that both parties receive a fair share of the pension entitlement accrued during the marriage or partnership.
The idea behind pension sharing is to ensure that the financial interests of both spouses are protected post-divorce. This is particularly important if one party has accumulated a substantial pension while the other has not. Rather than simply splitting the pension pot in half, pension sharing allows for a more equitable distribution of pension benefits, depending on individual circumstances.
2. How Does Pension Sharing Work?
Once the court has granted a divorce, the pension assets are identified and valued. The value of the pension can be calculated using the “cash equivalent transfer value” (CETV), which represents the amount of money required today to provide the same level of income or benefits in the future.
Pension sharing orders can be made by the court, and they specify how much of each party’s pension will be transferred to the other. The options available depend on the type of pension and the specific circumstances of the divorce. Here are the main ways pension sharing can work:
Pension Sharing Order (PSO):
This is the most common form of pension division in divorce proceedings. A PSO allows for a percentage of one spouse’s pension to be transferred to the other spouse. The amount transferred will be based on the CETV and the proportion agreed upon by both parties or determined by the court.
Pension Offset:
In some cases, instead of splitting the pension, one party may receive other assets (like the family home or savings) in exchange for leaving the pension intact. This is called pension offsetting. It can be more straightforward than a PSO, but it might not always lead to the fairest outcome, depending on the value of the pension and other assets.
Pension Earmarking:
This method involves one spouse receiving a portion of the other spouse’s pension when they retire or begin drawing from the pension. This option is less common today but is still an available choice in some jurisdictions. The drawback is that it leaves one spouse reliant on the other’s retirement decisions.
3. How Do You Value a Pension?
The value of a pension is typically calculated using the CETV, which takes into account the amount of money needed today to provide the same benefits at retirement. The CETV will be based on several factors, including:
- The type of pension (defined benefit or defined contribution)
- The member’s age
- The level of contributions made
- Any early retirement provisions
- The projected pension value at retirement
It’s important to get accurate valuations for all pensions involved, and if necessary, to seek professional advice from a pension expert or actuary. An inaccurate valuation can lead to unfair financial settlements.
4. What Happens to Pension Types After Divorce?
There are different types of pension arrangements that need to be considered when sharing pensions in a divorce:
Defined Benefit (DB) Pensions:
These are pensions where the retirement income is based on a formula (such as years of service and salary). DB pensions are typically more complicated to value and divide, but a pension sharing order can be made to transfer a portion of the pension’s value to the other party. In these cases, the pension plan itself will usually handle the transfer of benefits.
Defined Contribution (DC) Pensions:
DC pensions are based on contributions made by the individual and the employer, with the final retirement pot dependent on investment returns. If you are awarded a share of a DC pension, the value can be transferred to your own pension fund. If you’re the one who has to transfer a portion of your pension, the value can be moved to your ex-spouse’s pension.
State Pensions:
State pensions are not typically divided during a divorce, as they are considered the individual’s entitlement. However, if one spouse was the primary carer for children or took time off work, there may be the potential to adjust the state pension to reflect the years spent outside of the workforce.
5. How Long Does Pension Sharing Take?
The pension sharing process can take several months. First, the pensions need to be valued, then the court needs to issue a pension sharing order (if applicable). Once the order is made, the pensions are split or transferred according to the terms. While pension sharing can be complex, most couples can reach an agreement or have the court decide.
If you and your ex-spouse have an agreement in principle, it may take just a few weeks to formalize the pension split. However, disagreements over pension values, or difficulties obtaining necessary information, can extend the process.
6. What Are the Tax Implications?
When pensions are shared, there may be tax implications, depending on the type of pension and the country in which you reside. For example, in the UK, pensions are not subject to income tax at the point of the transfer, but you will need to pay income tax when you start drawing the pension benefits.
In some jurisdictions, the transfer itself may be tax-free, but you may need to consider how taxes will affect your pension income in the future, particularly if you’re receiving income from a pension as part of a divorce settlement.
7. Can You Appeal a Pension Sharing Decision?
If you are unhappy with the pension sharing order, you may be able to appeal it. However, challenging the decision is often difficult and requires substantial legal grounds. If there are serious concerns about the fairness of the split, it’s important to consult a family lawyer or pension expert early in the process.
8. Why You Should Seek Professional Advice
Pension sharing can be a complex and often contentious issue during divorce proceedings. It’s advisable to seek expert advice from financial advisors, pension experts, and family law solicitors to ensure you understand the full impact of pension division on your long-term financial security.
An expert can help you:
- Understand the true value of your pension
- Assess the potential impact of pension sharing on your retirement plans
- Make informed decisions regarding pension division and other assets
- Navigate the tax implications of pension sharing
Conclusion
Pension sharing is a crucial part of many divorce settlements, and understanding how it works can ensure that you achieve a fair and equitable outcome. Whether you’re dividing a pension through a pension sharing order, offsetting assets, or considering other arrangements, getting proper legal and financial advice is essential. By taking the time to understand the process and ensuring that you have accurate valuations and a clear understanding of your options, you can move forward with confidence in your financial future.
If you’re going through a divorce and need advice on pension sharing, don’t hesitate to reach out to professionals who can guide you through the process and protect your interests.
