Divorce is a topic that we rarely talk about – for understandable reasons. However, with around 40 per cent of marriages ending in divorce currently, the likelihood of this affecting some of your clients, with significant consequences for their financial planning, is incredibly high.
Moreover, the complexities it creates for the allocation of pensions mean the financial adviser has a critical role to play. We outline a few of the key aspects below – but first, it’s worth quickly touching on the legislative background.
Pension and divorce legislation
We have come a long way since the initial legislation governing pensions and divorce was developed in 1973 via the Matrimonial Causes Act.
The Pension Act 1995 made progress by allowing for pensions attachment orders for all divorces after 1 July 1996; later, the significant and arguably much-needed Welfare Reform and Pensions Act 1999 provided for pensions sharing, applying to divorces after 1 December 2000.
The upshot is that there are now three ways of addressing pension wealth in a divorce situation, each with their upsides and downsides.
The first method is to offset the value of the pension rights against a calculation of the value of other matrimonial assets, keeping pensions intact.
In many ways this is the simplest method available – it creates a clean break and, where both partners are reasonably well off, can be an effective approach. It is often used where overseas pension assets are involved to avoid the complications these create.
However, offsetting can throw up many challenges for the less well-off partner, particularly in relation to working out how to preserve any capital and indeed how to eventually turn that into a retirement income.
This refers to an attachment order made by the court, which requires a proportion of the pension benefits to be paid directly to an ex-spouse instead of to the member.
Before the most recent legislation came into force in 2000, this was a more common method of sharing, however it is little used now due to its significant downsides. For instance, the benefitting spouse could lose their entitlement if they remarry or, depending on the details of the pension scheme, once their ex-partner dies.
Needless to say, it definitely doesn’t produce a ‘clean break’.
This option, now two-decades old, is an acknowledgement by the state of the complexity of pensions.
The aim of pension sharing arrangements, generally requiring a court order, is to calculate the value that needs to be transferred to allow a spouse to achieve equal value or income by becoming a member of the pension scheme in their own right with the benefits shared between the two parties or transferring it into their own pension scheme. This has the obvious benefit of not being tied to the other spouse’s retirement date, enabling both parties to act independently in the future.
As with everything, though, there are some drawbacks. Not least, it affects the recipient’s lifetime allowance (LTA), that is, their ability to add additional funds – meaning high earners must take particular care.
The role of the IFA
We would encourage advisers to deploy their expertise early on in the process and to alert their clients to the availability of pension and actuarial advice where appropriate. There are three key aspects.
Property v pensions – dispelling the misconceptions
We still see instances of spouses without significant wealth veering towards the offsetting property route with little regard for the wealth contained in a pension.
Advisers will understand that while a family home could be worth perhaps £500,000, a DB pension from a long-serving employee could be worth more. A bank facilities manager who has worked for 25 years could easily have accumulated a pension worth upwards of £800,000, for instance.
An IFA can bring common sense to bear in making clear the best decision for the long-term.
Courts now typically require independent actuarial reports that can advise on ways of splitting the pension assets to achieve equal pension income, given the complexities involved.
However, the actuarial report is only one aspect of advice given. Both partners require support and financial expertise to assist them in making the correct choice of what form of pension share is best suited to their needs.
There is a host of considerations, such as which pension to take it from, which pension to give it from, how much has been given away or received, when it is payable from, what are the pension increases, and many more complex issues besides – the list is extensive.
The key takeaway is that both parties need to fully understand the future cashflow impact on their lives, whatever the potential options on offer. Cashflow modelling is therefore an essential service.
Planning for the future
Finally, once the settlement has been agreed, there is the essential role of implementing the plan.
For the less well-off spouse a key consideration is likely to be when they can afford to retire. The better-off partner, on the other hand, will likely be considering how to rebuild their pension.
The more, the better
Divorce ranks among the most valuable situation-specific areas of advice an IFA or a planner can provide.
And if anything, these decisions have become more challenging with the implementation of the pension freedoms.
Divorce isn’t easy, but it is common. Advisers have an essential role to play for their clients in helping them understand their situation, and choose the best options from there.
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About the author
David Downie, Group Chief Actuary, Embark Group
David has over 30 years of experience in Actuarial Consultancy mainly with James Hay and Rowanmoor where he has remained a Director. He is responsible for all actuarial services provided by Embark including holding the appointment of Scheme Actuary to several Defined Benefit Schemes. He also advises several Pre-Paid Funeral Plan Trusts and pioneered the concept of the defined benefit small self-administered scheme (DB SSAS) under the Post A-day simplification landscape.
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