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On divorce or dissolution of a civil partnership the court has to consider the assets of the couple, and try to achieve a fair division between them. Pension funds often represent a very significant proportion of a couple's assets, particularly if the couple have been contributing to the pension for a number of years. The importance of significant pension funds has always been acknowledged by the courts when dividing up the assets, but such funds pose greater problems on divorce or dissolution than do most other assets. Pensions are particularly difficult to deal with when trying to achieve a clean-break between the parties: that is dividing up the assets in such a way that neither party need pay maintenance to the other. The Court of Appeal recently confirmed that pensions are not like other assets, and even when they are already being paid to one or other of the parties are not to be treated as though they can be valued and distributed between the parties on the same basis as other assets. On 6 April 2006 (A-day) the Government completely revised the rules which govern pensions and a new range of issues emerged. The changes have a particular impact on those with a total pension pot of £1 million or more, and on high earners who have been in occupational final salary schemes for some years. The rules introduce a lifetime' allowance for pensions' savings of £1.5 million in 2006/7, rising incrementally to £1.8 million by 2010, together with a number of other significant changes. Couples divorcing, or dissolving a civil partnership, should take expert advice as to how the division of their assets, including pensions, may be affected by the A-day changes, in particular what the impact might be upon the pension benefits they will ultimately receive (see Expert Advice below)

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Unequal pension provision

Where both parties have pension funds, it is common for one of the funds to be much larger than the other, typically because the wife has interrupted her career to have children, and therefore has fewer years of contribution, and/or a lower income from which to make her contributions. In many cases only one person will have a pension fund, because both people have been expecting the fund to provide for their joint financial support on retirement. In some cases a pension will make specific provision for some sort of payment to a spouse or civil partner; entitlement to this has traditionally been lost after divorce or dissolution of the partnership.

On divorce or dissolution there is therefore often a disparity between the parties: one of them will have a relatively large pension fund available to them on retirement; the other will have a much smaller fund, if any fund at all. In view of the emphasis placed by the court on achieving a fair settlement between the parties, the court will usually want to remedy this disparity. If at all possible the court will try to ensure that both parties can look forward to a financially secure retirement. A number of solutions to the problem have developed, over the years, including sharing a pension belonging to one spouse or civil partner by allocating part of it to the other spouse or civil partner, see Solutions below.

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Restricted access to the funds

Pension funds are usually held under strict trusts, whose rules ensure that only the person contributing to the fund has any claim on the bulk of the money, and that even the person contributing to the fund is entitled to receive benefits only after they reach a certain age, or on certain conditions. The pension fund is not 'property' in a straightforward sense; the fund is controlled by the pension trustees or provider (such as an employer), not by the contributing spouse or civil partner, and the trustees or providers are bound by the terms of the trust. The Welfare Reform and Pensions Act 1999 has given the court the power to share a pension, but does not give the court the power to order the trustee of a pension fund to release money before the due date, so however large the fund, and however little the couple has at the time of the divorce or dissolution, this considerable asset is not available to either party until the due date under the terms of the pension and in accordance with government regulations. Even a pension in payment cannot be equated simply with a cash asset: in a recent case, the Court of Appeal pointed out that there were obvious distinctions between a technical value ascribed to a pension in payment and a market value ascribed to a realisable asset, such as a freehold, a portfolio of shares or a work of art, and criticised a judge for ignoring the essential differences between saleable property and an income stream derived from an inalienable pension in payment.

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Valuations

The valuation of assets is always fertile ground for disagreement between the parties, but valuing a pension fund is particularly difficult. Although it is possible to say how much is in the fund at any particular time, this may not be a very good guide to how much will be available to the parties on retirement, which is, after all, the really important question. In the years between the divorce or dissolution and the retirement a great deal could happen to the fund. Expert advice on valuation of a pension fund is important, and the cost of such advice must be taken into account, in proportion to the value of what is in issue. The changes introduced on 'A-day', 6 April 2006, may have made a significant difference to the value and the range of benefits available.

Under the Welfare Reform and Pensions Act 1999, which introduced pension sharing, only one method of valuation is allowed, the cash equivalent of shareable rights known as the CETV. This is the figure which the pension provider would be obliged to transfer to another pension fund on, for example, change of employment. It is the value at that particular moment and does not include any element to cater for future rises in salary or contributions, or for inflation. Although the CETV is the only valuation which the court is allowed to use when snaring a pension, and can only be challenged as to the accuracy of the calculation itself, the parties may produce other evidence of valuation in order to put the pension value in context in the particular case, and to draw the court's attention to any special factors. The court may take such factors into account in the final settlement, although not the pension-sharing itself. There are alternative values, such as 'past service reserve' which does take into account future salary rises, and the 'fund value' which might be more applicable to a small self-administered company scheme, or a self-invested personal pension (SIPP). There are also other forms of pension benefit which may not be obvious, such as additional voluntary contributions (AVCs), unfunded unapproved retirement benefit schemes (UURBs), funded unapproved retirement benefit schemes (FURBs) and other unfunded provision, which may require specialist investigation and evaluation.

Both the parties and the court will want to know the effect of any pension sharing order, and what it will leave in the hands of each party at the pension date. It is important to take into account the fact of women’s greater longevity and therefore equality of outcome and also factors such as ill-health which have an effect on what the pension fund will provide. Projections are not to be taken at face value, but expert advice on what each party is likely to receive from the fund on retirement is essential. Whatever method is used to assess the retirement value of the pension will merely be a forecast, and financial forecasts are, like weather forecasts, only ever a best guess.

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Financial security

Possible fluctuations in the real value of the fund are one problem, possible changes in family circumstances are another. Even if both parties are satisfied that the valuation of the fund is reasonably accurate, neither they nor the court can be confident that the fund will be sufficient to provide complete financial security. Changes in circumstance, for example a severe illness, or redundancy could limit future contributions to the fund, seriously affecting current forecasts about the fund's value. Equally, such changes could have a big impact on the needs of one of the parties, so that a sum which seemed to offer security at the time of the divorce or dissolution would in reality be insufficient on retirement.

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Expert advice

When working out how to deal with the pension fund, it is vital to obtain both legal advice and advice from an independent financial adviser. There are a number of ways in which the court may deal with the pension, but only after obtaining expert advice can the parties identify the best course for them. The changes which took place on 'A-Day', April 2006 will require special consideration. The value and the availability of benefits may be affected by the new rules, and a range of possible protective steps will need to be considered. [See Pension Simplification below]

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Solutions

Pensions Sharing

On 1 December 2000 the Welfare Reform and Pensions Act 1999 came into force, giving the court jurisdiction to divide a pension fund between spouses on divorce. The Civil Partnership Act 2004 amended the 1999 Act to give the court the same power to divide a pension fund between civil partners dissolving their partnership.

Division of the pension fund is in percentage terms, to avoid some of the valuation problems discussed above. The relevant percentage is 'debited' from the pension of the person who contributed to the fund, and 'credited' to the pension of the person who did not contribute. The percentage does not have to be a 50/50 split; the Court of Appeal recently suggested that, given the very unusual nature of the pension as an asset, the fairest way to deal with pensions was to share the pension provision of the parties in the same proportions as the rest of the assets. It is not in general acceptable to leave one party with the bulk of the pension as their principal share of the assets.

It is also possible, under the Act, to order that death in service benefits from a pension scheme or death benefits from a policy be paid to the non-contributing spouse/civil partner, which may be crucial in protecting the financial well-being of a non-contributing spouse or civil partner whose income in the form of maintenance is lost on the death of their former spouse/civil partner but it is not possible to make this order and make a pension sharing order in respect of the same pension arrangement.

If the pension is to be shared the non-contributing spouse/civil partner will be able either to become a member of the scheme of the contributing spouse/civil partner (an internal transfer) or to transfer the percentage designated by the court into a different pension scheme (an external transfer). Most private schemes insist on an external transfer, while for the public sector schemes, such as the civil service, teachers, police etc, the transfer must be internal. At present an external transfer is likely to reduce the value of the new fund, but may still be preferable as it will give complete control over the fund: some schemes which allow an internal transfer do not allow the person who has acquired an interest to make further contributions to the new fund.

It is only possible to arrange pension sharing on a decree of divorce, dissolution or nullity (and only if the original petition was filed after 1 December, 2000), and only by order of the court, not by private agreement. A particular pension can only be shared with a particular spouse or civil partner once, although it is possible on a subsequent divorce or dissolution involving a different spouse or civil partner to share a pension which has previously been divided in earlier proceedings. It is not possible to share a pension which is already subject to an attachment order.

The cost of pension sharing is not to be under estimated. The pension provider is entitled to charge up to £150 for providing an additional cash equivalent transfer value (beyond the annual free CGV) and up to £750 for administration costs. For a pension in payment, which can also be shared, the valuation will cost up to £500 because it has to be specially calculated and the administration costs will again be up to £750.

It will be appropriate in every case to consider pension sharing, but pension sharing will not always be the preferred solution. There are clear procedures for obtaining the necessary information from pension providers so that a decision can be made with the benefit of expert advice as to whether or not pension sharing is appropriate in a particular case.

The 'A-day' changes have a significant impact on pension sharing arrangements and it is very important for those contemplating a pension share as part of their financial arrangements on divorce to consider what the effect of the changes will be on them. [See Pensions Simplification below.] After A-day, civil partners, husbands or wives with substantial existing pension rights of their own may be less interested in taking a share in the larger pension of their former civil partner or ex-spouse, because of the risk of exceeding their own lifetime allowance, and incurring a tax charge.

Open-ended Maintenance

The spouse or civil partner with more money, and a pension fund, may be ordered to make regular maintenance payments, index-linked, to the spouse or civil partner with less money, these payments to continue past retirement age. If this happens the pension fund does not need to be divided, because it will form part of the fund from which the maintenance is paid. However, such maintenance involves long-term dependency of one party on the other, is likely to restrict the freedom of the party with less money by posing a bar to remarriage or re-registration, and will prevent either party from making a completely fresh start. If long-term maintenance is the order made, the disadvantage is that the pension dies with the pension holder and the dependent spouse or civil partner, and any child, would be well-advised to seek a court order attaching the death in service benefit in their favour, or, if affordable, by insuring themselves against the death of the person paying maintenance. The Welfare Reform and Pensions Act 1999 does enable the court to give greater protection to dependent former spouses and civil partners by ordering long-term maintenance plus payment of any death benefits from the pension scheme. (see Pensions Sharing).

State provision

It is necessary to take into account the state retirement provision, even though this cannot be shared. Information should be obtained as to the contributions made and the pension payable as a wife can rely upon the contributions made by her husband up until Decree Absolute. Likewise a valuation of the state earnings related pension scheme (SERPS) should be obtained if appropriate.

Off-Setting

Off-setting involves assessing the value of the pension fund, then using other assets to compensate the person without the pension for their loss of pension support. The money or asset which the party without the pension receives can be used to make provision for retirement. This has been the most common approach to the problem of pensions in the past, but it can happen only if the couple have substantial assets which they can divide up relatively easily, leaving both parties with enough to live off, and somewhere to live, until both pensions mature. Even in such cases, the Court of Appeal's recent comments about the unfairness of leaving one party with the pension while the other receives more liquid assets will presumably make off-setting more rare. Offsetting also raises particular problems in regard to valuing the pension, and to assessing the parties' likely future circumstances, mentioned above. The parties can, of course, agree to off-set, having taken proper legal advice, if that suits their personal circumstances. The cost of pension sharing, and the adverse effect of women's longevity upon what pension they can buy, may meanthat for some offsetting remains the best solution.

Attachment

Attachment, which used to be called earmarking, allows the court to order the pension trustees to administer the fund in a particular way, so that the person named in the order is provided with income from the fund or with a lump sum when the fund matures. Although this remedy can be of assistance where the pension holder does not pay maintenance reliably, or when the court wants to achieve a clean break at some future stage, or when a death in service benefit is to be made available, its disadvantage is that either party can apply to the court to vary the amount paid, and that it dies with the pension provider. It is not possible to attach and to share the same pension.

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Pensions Simplification 2006

On 6 April 2006, 'A-day', the Government completely revised the rules which govern pensions. The changes have a particular impact on those with a total pension pot of £1 million or more, and on high earners who have been in occupational final salary schemes for some years.

The rules introduce a 'lifetime' allowance for pensions' savings of £1.5 million in 2006/7, rising incrementally to £1.8 million by 20010. A factor of 20:1 will be applied to determine the capital value of a pension, so that a pension of £50,000 pa will be valued at £1 million, while a single factor of 10:1 will be used to value defined pension benefits against the annual allowance. The rules also introduce a tax-free lump sum of 25% of the pension fund available at maturity, up to the lifetime allowance. There is a lifetime allowance recovery tax charge of 25% on funds in excess of the lifetime allowance if used to provide a pension; alternatively these excess funds can be taken as a lump sum subject to a tax charge of 55%. There is an annual limit on contributions, except for the final year prior to retirement, of £215,000, rising incrementally to £255,000 by 2010/2011. Total employee and employer contributions above this threshold will lead to a 40% tax charge on the excess amount. Tax relief for individuals will be granted only on contributions up to 100% of UK earned income. Unapproved schemes will be exempt from the new regime, but current tax privileges will be withdrawn from them.

For those in danger of breaching the lifetime allowances, there are two types of possible protection available: primary protection and enhanced protection. Registration for such protection must have taken place within three years of A-day, so must have happened before 6 April 2009. Under primary protection those with pension funds worth more than £1.5 million on 'A-day', 6 April 2006, but whose benefits are within current limits, are able to register their actual fund value as a percentage of the lifetime allowance and receive a lifetime allowance 'enhancement factor'. Enhanced protection is available to everyone whose benefits are within current limits, including people applying for primary protection, and exempts all benefits paid out after April 2006, irrespective of their value, provided no further pension contributions have been paid into the fund since A-day, and no benefits have accrued since then.This is potentially attractive to people with substantial funds who anticipate that these might grow sufficiently to exceed the lifetime allowance in due course. In some cases, people whose tax-free lump sum entitlement on 6 April was more than 25% of their fund value can retain their higher entitlement.

The new legislation has no direct impact on maintenance payments, off-setting or attachment orders. However, in all cases the value of the benefits available from the pension may be affected by the new rules. Attachment orders will have the new disadvantage that all the benefits from the fund will be treated as benefits paid to pension member despite the fact that a portion of the benefits will in reality be being paid to the former civil partner or ex-spouse. In addition, the timing and the amount of benefits payable may change, and the tax-free cash element may increase.

A-day does have an appreciable effect on high value pension sharing arrangements. After A-day, civil partners, husbands or wives with substantial existing pension rights of their own may be less interested in taking a share in the larger pension of their former civil partner or ex-spouse, because of the risk of exceeding their own lifetime allowance, and thereby incurring a tax charge.

Since A-day the value of a transfer to an ex-spouse or former civil partner does not count against the pension member's lifetime allowance, but against the lifetime allowance of the ex-spouse or former civil partner. A person whose pension is shared with an ex-spouse or former civil partner will therefore be able to rebuild their funds back up to the lifetime allowance. From the perspective of the ex-spouse or former civil partner, a transfer received before A-day will not count against the lifetime allowance, provided that the right to an additional lifetime allowance is registered by 5 April 2009. The value of any transfer received after A-day will count against the lifetime allowance, unless the source of the credit is a pension already in payment, in which case the ex-spouse or former civil partner can register the pension credit for an additional lifetime allowance. The pension credit will not, however, count towards the annual contributions limit. A transfer agreed before A-day needs to be taken into account when assessing the maximum benefit entitlement which can be protected by enhanced or primary protection. If a pension member has registered for protection, and pension sharing arrangements are agreed after A-day, the protected lifetime allowance will be reduced in the same proportion as the percentage shared with the ex-spouse or former civil partner.

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