Going through a divorce is challenging, not least when you’re deciding how to split up assets. Amid the turmoil, you may overlook one key asset: pensions.
For many people a pension is likely to be one of the largest assets they own, often coming second only to property. Yet, pensions aren’t discussed as much as other assets in day-to-day conversations and can be neglected during divorce proceedings. It’s an oversight that could have a significant financial impact in the future.
Pensions apathy has been highlighted by a study from Fidelity International. It found 56% of married women don’t have arrangements in place to protect their pensions in divorce. Similarly, 60% of married men said they didn’t have pension plans if their marriage broke down. Considering how financially secure you’d be should a relationship breakdown might not be a pleasant topic, but it’s an important area to understand.
It’s becoming more common for pensions to be discussed and split during a divorce. There are essentially three ways of doing so. If you find yourself needing to split pensions with a partner, which option is right for you will depend on your priorities and circumstances.
Pension earmarking may also be referred to as pension attachment. It gives one party a portion of the pension of the other. This becomes available when the person starts to draw retirement benefits. Pension earmarking can either be defined as a specific figure or as a percentage of the pension, this is predefined during the court process. The court will also instruct the scheme administrator or pension provider to make these payments.
The flexibility you have with pension earmarking will depend on where you live. In Scotland, you can only receive a lump sum when the pension is first accessed, known as a pension commencement lump sum. If you live in England, Wales and Northern Ireland you can also receive income on an ongoing basis.
A pension earmarking order isn’t used as commonly as a pension sharing order; however, use is rising. Statistics show between Pension Freedoms being introduced in 2015 and 2018, the number of pension earmarking orders made increased by 60%.
Whilst a pension earmarking order can provide you with either a lump sum or an income in retirement, it does come with drawbacks. Importantly, it means your finances remain tied to an ex-partner and you may need to adjust retirement plans to suit when they intend to access their pension. If they decided to not access their pension for an extra five years, how would it affect your financial security?
If this is an option you choose, it’s crucial that you understand what you’ll receive through a pension earmarking order and when. You’ll then need to assess how this suits your own retirement plans and provisions.
Pension sharing orders were introduced in 2000 and offer a legal way of dividing up a pension. Prior to this, a spouse or civil partner would have no pension entitlement on divorce. Pensions are now included when calculating the total value of material assets and can be divided equally.
When using a pension sharing order, a partner with no pension or a pension with a lower value may be awarded a portion of their ex’s pension. This is known as a pension credit. The crucial difference between a pension sharing order and a pension earmarking order is that the pension credit is given to the individual now, rather than having to wait until the pension is accessed. A pension credit can be transferred into either an existing pension or used to open a new one.
This option allows couples to make a clean break financially and can be attractive for this reason. In fact, the number of pension sharing orders has increased by 40% between 2015 and 2018. However, you’ll need to think carefully where to place the pension credit awarded and how it fits into your wider financial and retirement plans. A pension sharing order means you’ll have no entitlement to your ex-partner’s pension when they retire.
An alternative to the above two options is pension offsetting. This is where you’d receive a larger portion of other assets in return for giving up a pension entitlement. For example, you may decide that you’ll take a bigger share of property wealth or savings and investments in return for leaving your spouse or civil partner with their full pension. One of the challenges here can be calculating how much a pension is worth and, therefore, how to offset it.
Again, this option means you can make a clean break financially and it may improve your financial situation in the short and medium-term. The important thing to keep in mind here is your long-term financial security. You’ll need to assess your own retirement provisions and the steps you’ll take between now and the point of retirement. If this could leave you with a shortfall, a pension offsetting agreement may not be right for you.
Securing your financial future after divorce
Going through a divorce may be a time of upheaval for you and it’s likely that your priorities and aspirations will change. Taking steps to understand where your finance stands during the divorce process and how it’ll impact your long-term plans is important.
Whilst this will cover usual day-to-day costs, such as paying a mortgage or setting money aside in an emergency fund, you also need to be looking at the future. Understanding how your pension provisions may have changed and what you need to do to secure the retirement you want means you can start the next stage of your life with confidence.
This is an area working with a wealth manager can help. We’ll help you understand how divorce has affected your financial security and whether previous plans are still appropriate given your changing priorities. Our goal is to help you understand your options and which path is right for you. If you’ve experienced divorce and want to get to grips with your financial future, please get in touch.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
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