The Affect of Divorce on your Pension

When a couple get divorced, there is no set formula for dividing assets between the two parties. A pension may be taken into account in a variety of ways – offsetting, earmarking, and sharing.

Offsetting

Offsetting is the most preferred method of dividing assets because it is the simplest and provides a ‘clean break’ in financial terms. Under this method, the value of the pension is ‘offset’ against other assets held within the marriage. The ex-spouse would, therefore, receive a greater share of the balance of the assets in return for the loss of their ‘share’ of the member’s pension benefits.

The division of assets is not always 50/50 and in some cases, if the husband and wife have their own pension provision, the pension may be ignored altogether.

The valuation of the benefits to be offset depends on the type of scheme. The cash equivalent transfer value is used and this represents the gross value of the member’s benefits. Final salary scheme benefits are calculated taking into account the loss of member’s pension, spouse’s pension, tax-free cash and death in service benefit. Money purchase scheme benefits are easier to calculate because offsetting can be settled by agreeing a percentage of the fund value.

Offsetting is made at the time of the divorce and there will be no effect should the member or ex-spouse subsequently re-marry or die.

Earmarking

Earmarking allows the ex-spouse to ‘earmark’ benefits in the member’s pension scheme so that they will receive income and/or lump sums in the future. There are two types of earmarking order:

1. periodic payment orders, which will commence when the member starts to take their own benefits, and which are defined as a percentage of the member’s pension; and
2. lump sum orders, under which part, or all, of the member’s tax-free cash can be paid to a former spouse.

However, there are disadvantages to making an earmarking order, e.g. the ex-spouse could lose track of the benefits should the member change address or transfer the pension to another provider; and, if the member dies, or the ex-spouse re-marries, the period payment order will end.

Sharing

Pension sharing is the third option, if the divorce petition was submitted on or after 1 December 2000 and divides the scheme member’s pension rights at the time of divorce.

The ex-spouse receives the transfer value shortly after the sharing order is made. Although they will not actually receive any physical assets until benefits become payable, the ex-spouse can control when that will be. The benefits awarded to the ex-spouse are known as a pension credit and the value of benefit deducted from the member is known as a pension debit. The pension credit and debit are expressed either as a percentage of the fund or, in the case of final salary scheme, as a number of years.

There is no effect if either party re-marries. However, both the member and ex-spouse will be charged income tax on the income which they receive from the pension.