Pensions and divorce: a guide to pension sharing order rules

Can I protect my pension if I get divorced?  

It’s natural that many people feel protective of their private or workplace pensions and may be concerned about giving up any entitlement to it, if they get divorced. However, pensions are considered as marital assets by the courts, which means they are often a central part of any divorce settlement – especially if your ex has a lower income or less wealth than you. 

The courts will want to ensure that both parties in the marriage are treated fairly when they go their separate ways, with provision for each individual’s long-term financial security wherever possible.

How are pensions split in a divorce or dissolution? 

Exactly how a pension will be shared in a divorce (or dissolution of a civil partnership) will depend on your own personal circumstances. However, there are typically three ways for pensions to be split – each of which has its own pros and cons, depending on your position.  

There might be some limited cases where a combination of options could be used – but you wouldn’t, for example, be able to have a pension sharing order and an earmarking arrangement on the same pension rights. 

Even if you are divorcing in retirement, and have started drawing on pensions, it is still possible for them to be split.  

Pension sharing orders

Sometimes referred to as ‘pensions splitting’, this approach involves dividing a pension between the two parties at the time of the divorce. The payment is referred to as a pension credit, if you are receiving it, or a pension debit if you are paying it. 

The spouse that receives the money doesn’t just get a pension lump sum to do with as they wish – rather, the credit must be transferred into their own pension, either with the original pension provider or their own scheme, if it accepts transfers. 

It is possible to make a pension sharing order against one or multiple pensions, depending on the circumstances. 

You can also share a pension that is already in payment, however, as this process is more complicated, you may also have to pay a higher fee to your pension provider to arrange this.

Pros

• The main advantage of this type of arrangement is that it provides a clean break for divorcing couples and ensures both have provision for retirement income, which they can independently control.
• The arrangement will also be unaffected if there is a change of circumstances, for example one of you remarries or dies.
• In many cases, it also means that the person giving up their pension may be able to keep more of their non-pension assets, such as savings and investments or property. 

Cons

• Although one party gets a pension credit, it may mean they get less non-pension assets, which may cause some financial stress in the short-term, especially if retirement is still a long way off. The pension scheme member will also get a reduced tax-free lump and income in retirement. Depending on timings, they may not be able to rebuild their pot to its original size, either.
• Another drawback for the ex-spouse receiving the pension sharing order, is if the scheme member has already accessed their pension benefits taking the maximum tax-free lump sum, the spouse receiving the pension sharing order will not be entitled to take any tax-free lump sum payment from that pension when they access this.  
• Additionally, since the pension sharing order provides a clean split, the ex-spouse receiving the pension credit will not be entitled to any death benefits from the pension if the scheme member dies. Fees for sharing pensions can be high and might not always be justified for smaller pensions. 

Pension attachment order (or earmarking): 

With this type of arrangement a proportion of a scheme member’s benefits are ‘earmarked’ for their ex-spouse. This can potentially include entitlement to retirement income, tax-free cash (also referred to as pension commencement lump sums) and death benefits. 

However, unlike, pension sharing orders, the arrangement only starts when the original member starts taking benefits (or dies), meaning there is no clean break for divorcing couples. For this reason, this approach is not used as frequently as pension sharing orders.

Pros

• No money is transferred at the time of the divorce and the pension scheme member will get the earmarked benefits back if their ex dies.
• On the plus side for the ex-spouse due to receive the benefits, they won’t have to pay tax on income payments and may still benefit from death benefits if the original scheme member dies.

Cons

• With earmarking there isn’t a clean break and the scheme member retains control over their pension – for example where it is invested or the timing of benefits, making it harder for the ex-spouse to plan their retirement finances.
• For the pension scheme member, a major downside, is that they will have to pay tax on payments to their ex (as it still counts as their income).
• Payments to the ex-spouse will also end if they remarry or enter a new civil partnership. If the scheme member dies, death benefits would only be paid to the ex if that was part of the original agreement.

Offsetting

Instead of physically splitting a pension, some couples will agree to offsetting. This is where one party keeps their pension but gives up more non-pension assets instead, this can be any asset, but is most likely to be the property. 

For example, the party that has full-time custody of the children may get full ownership of the family home, in lieu of a stake in the other party’s pension. 

Pros

• Offsetting can be the most straightforward way of tackling the pension problem in a divorce and costs less to implement than pension sharing orders or earmarking arrangements – particularly for smaller pensions, where charges can outweigh the benefits.
• It also gives divorcing couples a clean break, with no further complications if either remarries or dies. It may also be the only option if overseas pensions are involved as they cannot be split in a UK court.

Cons

• The main disadvantage to offsetting is that it can leave both parties finances unbalanced post-divorce.
• While one party might get to keep their pension, they could be left without the necessary funds for short-term needs, for example to buy a new home themselves.
• The other party, meanwhile, might get the benefit of keeping the family home but have minimal provision for their own retirement. 

Problems with offsetting 

Offsetting won’t be an option for every divorcing couple; it can only work if there are sufficient non-pension assets (like property or savings and investments) to offset the pension against in the first place. It will also be difficult to implement if the value of the pension is disproportionate to the value of other assets held by the couple. 

Striking a fair deal with pensions offsetting can be difficult too. Not only can the value of different assets change over time, but pensions are notoriously difficult to value. Divorcing couples may underestimate their worth, especially if retirement is a long way off, or there are more pressing short-term financial worries for divorcing couples to contend with, such as where they will live or how they will pay the bills.

Finally, what to consider… 

When negotiating divorce and pension splitting, it’s important to consider not only your short-term financial needs, but also your long-term requirements, even if they do not feel pressing at the time. 

To ensure that the divorce settlement is fair, it is essential that both parties take independent financial advice along with legal counsel – especially if the value of any benefits they get are likely to be less than they had anticipated. 

Both parties will also need to understand the scheme in question’s policy on divorce and establish whether pension transfer advice will be necessary. 

While pension providers can provide valuations for pensions, these might be too simplistic for pension sharing purposes – especially if defined benefit pensions, like public sector schemes, are involved. In many cases it makes sense to get a professional pension valuation from a specialist actuary. This can take time and brings additional cost, but it can prove invaluable in ensuring the split is fair.