Pensions and divorce. What is a Pension Sharing Order (PSO)?
Pensions and divorce. What is a Pension Sharing Order (PSO)?
How are the family assets divided after divorce?
When any relationship comes to an end, it is often a difficult time for all involved. When a marriage comes to an end the extra stress involved in the sharing and division of a couple’s financial assets can add extra stress to what is already an emotionally draining time.
From a financial perspective, the starting point for divorce negotiations is for both parties to reach an amicable agreement as to how the combined assets will be divided. This agreement can then be written into a ‘Clean Break’ Consent Order during the divorce, which is a legally binding contract that will dismiss any future financial claims between parties.
However, we all know that divorces are often filled with emotion and sometimes an amicable split can’t be reached, at this point divorcing parties can ask the Court to decide how the assets should be shared. In this case, the courts will often start with considering a 50:50 split of the assets acquired during the marriage and go from there. Moving away from an equal division will often be down to external factors, such as whether one party has brought a large inheritance into the family, or if one party has been and continues to be the primary carer of the children and therefore has greater income needs. Essentially, it’s the question of ‘needs’ that determines if there will be an uneven split in the family assets - a divorce between a couple of equal age, health and income, without children, will generally result in an equal division of assets, regardless of whose name the assets were in.
When calculating the assets available at divorce, everything should be considered; including cash, investments, property, cars, valuable items and, of particular interest to this article, pensions.
How are pensions shared after divorce?
The value of pensions may not always be the first thing that comes to people’s minds when considering their finances when getting divorced, however, outside of a house, it’s often the case that pensions may be one of the biggest assets. In many cases though, pensions can be worth multiples of the equity that is held in the family home so it’s an incredibly important thing to consider as part of any divorce. Be aware though that although Pension Sharing Orders apply to most types of pension, they don’t apply to all.
When it comes to sharing pensions after divorce, couples can choose from three basic options:
Share the pension: A formal agreement (via a PSO) is made to divide the value of the pensions. The exact portions that will go to each party are decided and the assets are transferred into the receiving party’s name. They may be able to choose whether to stay with the existing pension provider or move to a new one. Alternatively, they may have no choice but to move to a new provider.
Offset the value of the pension: This is where the total value of the pension is comparable to the value of other assets. For example, one party could keep the pension and the other could keep the house and some cash. Getting a fair and true valuation of all the assets is really important and it should be noted that pension offsetting often results in a poor outcome for the person who does not have any pension assets.
Earmark the pension(s): This is a formal agreement (via an Attachment Order) to share the income produced by a pension once drawdown or retirement begins. Be aware that in this situation, there is no legal transfer of ownership of the pension, so you will be financially linked to the other party for life.
This article aims to focus on the first option, the formal sharing of the pension assets via a Pension Sharing Order. These are an excellent proposition when aiming for a total and clean break from the other party and the ability to make free and independent financial decisions post divorce.
What is a pension sharing order?
Pension Sharing Orders were introduced in the UK in December 2000. A Pension Sharing Order (PSO), is a formal agreement to divide an existing pension as part of a divorce financial settlement. Once split, the pensions will be legally owned by each party of the divorce. It’s worth noting that Pension Sharing Orders can only occur as a result of a court order, whereas most other types of asset (property, cash, etc.) can be legally transferred outside of court, via a solicitor. This is because pensions in the UK have some complex rules around taking money from and transferring ownership of pensions and therefore can only act upon the instruction of a court.
Although Pension Sharing Orders are an option across the whole of the UK, in Scotland only the assets accumulated over the course of the marriage/civil partnership are open to consideration, whereas, in England, Wales and Northern Ireland all the pension assets are considered.
It’s also very important to understand that it is only pensions which are held within the UK which count - any pensions that have been transferred overseas from the UK are out of scope of a Pension Sharing Order.
When it comes to defined contribution (DC) pensions, such as personal pensions and SIPPs, because the value of these pensions continuously fluctuates in line with the value of the investments held in them, it’s crucial to keep working with the most up to date pension valuation as divorce settlements can take a long time to agree. Likewise, defined benefit (DB) pensions, such as final salary and career-average schemes, can fluctuate in value based on the actuarial valuation applicable at the time the value is requested. The actual amount to be retained by each party in the Pension Sharing Order is expressed as a percentage of the Cash Equivalent Transfer Value (CETV). In Scotland, the amount shared can also be expressed as a figure (as opposed to only a percentage). The final CETV is calculated the day before the PSO is actioned.
Once the pension has been shared, the receiving party becomes the full legal owner of the pension and will retain full, independent autonomy in the future.
As an example, if the value of a pension was £478,210 and the PSO was for an even, 50:50 split, a 50% share would give each person £239,105.
This is a very simple example and often a pension share is determined only after a report has been commissioned from a Pension on Divorce Expert (PODE). A PODE is a highly qualified and experienced professional, often an actuary or an independent financial adviser. The analysis completed by the PODE will take account of multiple factors which can influence what the actual percentage split should be to ensure it is fair to both parties, including each party’s age, health, existing pension provision, options and guarantees within those pensions, and State Pension entitlement.
The part of a pension that is apportioned to a recipient of a Pension Sharing Order is called a pension credit. The part of a pension due to be retained by an owner is called a pension debit.
How long does a Pension Sharing Order take to implement?
A PSO must be completed (i.e. transferred to the receiving party) by the ‘implementation period’ deadline, which is a period of four months from the effective date of the Pension Sharing Order. You can find out what happens if a PSO deadline is breached in our article on that topic.
What are the benefits of a Pension Sharing Order (PSO)?
One of the primary benefits of a Pension Sharing Order is that it provides both parties with a pension in retirement. A Pension Sharing Order also gives both parties a clean break from each other and because of this, if they remarry or pass away, their finances remain independent from the previous spouse.
What are the downsides to a Pension Sharing Order (PSO)?
The downside of splitting a pension via a Pension Sharing Order is that it can seriously impact the original pension owner’s financial plans as they will be entitled to a much-reduced cash lump and/or income. Contrast this with sharing the equity in a family home, whereby it’s always an option for both parties to downsize or rent, whereas building up retirement savings usually takes decades. Equally, if the recipient of the PSO is a high-earner, they may find a PSO could affect their lifetime allowance due to the increased value of their pension provision.
Another aspect of PSOs to consider is there may be additional charges involved in making the split and the work associated with preparing a Pension Sharing Order, plus PSOs can be difficult to implement due to the illiquid nature of the funds in some pensions, particularly commercial property in Small Self-Administered Schemes (SSAS pensions).
Conclusion.
It’s clear that in many situations, Pension Sharing Orders are a fair way of providing a retirement income for both parties in a divorce. However, some caution needs to be paid to where in the UK the Pension Sharing Order is issued, the types of pension being considered and the larger impact that a Pension Sharing Order may have on both party’s lifetime allowances and financial needs in both the short and long-term.
What’s next?
If you need help or advice on your personal or business finances, you can get in touch with one of our advisors for independent financial advice. We offer a free initial consultation and although we are based in Tunbridge Wells, we advise clients across the UK.
This article offers information about pensions and tax and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and the benefits depend on individual circumstances.