How do you split pensions in a divorce fairly?

The tricky task of dividing pensions fairly in a divorce and stamping out ‘unintended discrimination’ against women is tackled by top lawyers in a newly published guide.

Pensions are often a family’s second most valuable asset after a home, but the legal experts found a widespread lack of confidence among colleagues in the profession about how to split them, and a substantial proportion of unfair outcomes.

Previous research has found divorcing women could be forfeiting thousands of pounds of pension cash, and a charity has called for lawyers to prompt couples to discuss the topic during the process.  

The new good practice guide seeks to address this by demystifying pensions jargon, encouraging fairer settlements, and reducing the risk of claims against lawyers by former clients.

The Pension Advisory Group of experts was partly funded by independent research group the Nuffield Foundation, which notes the small amount of sometimes contradictory guidance previously available was chiefly geared to big money divorce cases.

‘The project aimed to make a major improvement to the practice of pensions on divorce and will be of particular benefit to those divorcing couples who are not fabulously wealthy but nevertheless hold pensions of some value,’ says the foundation.

Rhys Taylor, a barrister who has answered reader questions on divorce for This is Money, said: ‘I hope that the PAG report will assist a more consistent and better informed approach to the treatment of pensions on divorce.

‘Pensions on divorce remain, perhaps, the last bastion of unintended discrimination against women in family law.’

Women are disproportionately affected because the pensions chasm at retirement is far wider than the 18 per cent gender pay gap recently revealed by the Government – although younger generations are better off than those currently reaching retirement.

But women reaching 65 now are retiring on pension funds a fifth the size of men’s because, in addition to having lower salaries, they are more likely to have career breaks, take part-time jobs and have caring responsibilities, according to a recent report by financial adviser LEBC.

It has produced a guide offering practical tips to women on how to boost retirement savings and help close the pensions gap.

If couples have similarly-sized pensions, it could make splitting them less of an issue in any divorce. 

The Pension Advisory Group report covers topics including the following, and can be read in full here. 

– Gathering the fullest possible information on all pensions held by divorcing spouses – including state pensions, death benefits, and guarantees – and how best to value them, including whether a ‘cash equivalent’ measure is appropriate.

Methods of reaching agreement include a pension sharing order, an old-style and now rarer pension attachment order, and offsetting which means spouses retain their own pensions in lieu of something else. See the the box on the right, and below.

The report emphasises, in bold text: ‘Ignoring the pensions or agreeing to ignore the pensions is not an option.’

– Offsetting, the process of trading off present or future pensions for other valuable joint assets, such as family homes.

The report notes that negligence claims against family lawyers over pensions overwhelmingly relate to ‘ill-considered’ offsetting agreements.

‘Offsetting may be desired by parties and in some circumstances may be the only feasible option,’ it says. ‘The result, however, needs to be considered and fair, and it is important that people engaged in the process know the value that they might be losing, retaining, or acquiring.

‘It is possible to use a mixture of offsetting and pension sharing to resolve a case fairly.’

– Complications that can arise when valuing and splitting final salary – also known as defined benefit – pensions in a divorce.

These can include what to do when a final salary scheme is closed, underfunded, or in the public sector.

– The impact of pension freedom reforms in 2015, which allow over-55s to access pensions and spend or invest them as they wish.

Flexible income drawdown, where a pension is invested to fund retirement, requires people to accept risks including the ups and downs of financial markets, interest rate changes, pound cost ravaging, and not knowing when you will die and therefore how long a pot must last. 

– How tax issues might affect decisions over pensions. The report alerts lawyers to the risks of people dipping into pension pots while still making contributions, and risking a shock tax bill if they unwittingly pay in too much.

This is known in financial jargon as triggering the ‘Money Purchase Annual Allowance’, and we explain the pitfalls of this here. 

The report also highlights the risks attached to the Lifetime Allowance, the maximum you can put in a pension and still benefit from tax relief.

‘The Lifetime Allowance is designed to restrict the maximum amount that people can accrue in pensions but people with prior accrued pensions might have protected their privileged status through allowed mechanisms.

‘There are many issues to be aware of with the Lifetime Allowance, including that a pension share might lead to loss of protected status and tax charges; but on the other hand, a pension sharing order might enable the parties to utilise two sets of Lifetime Allowances instead of one.’

– What happens when a pension is located abroad, or moved abroad. Pension Advisory Group member Rhys Taylor answered a question on this topic for This is Money here. 

– A range of other ‘complicating factors’ such as retirement ages, charges, the risks attached to different types of pensions, and destination funds after pensions are split.

Hilary Woodward, honorary research associate at the Cardiff School of Law and Politics, said: ‘The aim of this guide is to help judges and practitioners navigate their way with more confidence through the tricky field of pensions on divorce, and ultimately improve the fairness of outcomes for those going through divorce.’