Ipswich: 01473 214481
Norwich: 01603 617351
Chelmsford: 01245 215660
Contact us

Pensions in Family Finance

These are the notes of a talk given to the Norfolk & Norwich Law Society on 18 June 2015 as part of a seminar given by EA Law - East Anglian Chambers entitled “Family Finance”
Pensions in Family Finance Kate Miller
The Basics - valuing a pension
Defined Contribution
  • The simplest type to value, a straightforward investment so a recent CEV is going to be a reliable indication of the value  however, there are still some potential tricks
  • Watch out for any pension with “GAR” provision - this is Guaranteed Annuity Rate. Not generally available any more and can make the pension more valuable than the CEV might indicate as annuity rates have generally declined along with rates of return on investments and as life expectancy has increased.
Defined Benefit
  • Need to be very cautious about whether the CEV is a fair reflection of the value. On the most basic level:
    • Has H received a pay rise since the date of the CEV?
    • Death in service benefits are not factored into the CEV
    • £1 of CEV may not be sufficient to purchase anywhere near the same retirement income outside the scheme. 
  • Need to know what the options are on sharing i.e. whether an internal share is possible or indeed mandatory. As a rule of thumb, internal share is usually mandatory in the unfunded schemes (think of those with a ‘State’ connection) and with these one must be wary about the basis upon which the CEV is calculated; while an external share is usually mandatory in the funded schemes. If taking an external share, W is converting a defined benefit fund into a defined contribution fund and is most unlikely to be able to purchase equivalent retirement income. With some of the unfunded schemes there may be some very interesting issues around retirement date so it is important to know H’s normal retirement age and also what age W will be able to take a pension.
  • Watch out for the schemes where timing of the CEV can dramatically affect value - e.g. Army, Police, Fire Service - these schemes allow members to draw an immediate pension, irrespective of age, once a certain length of service has been achieved. 
  • For example, the Army (Other ranks) 1975 scheme* will pay an immediate pension on completion of 22 years’ service, for a soldier who signed up at 18 this can be as young as 40.  On the other hand, W will not be able to draw on her share of the pension until she reaches 55. 
  • Regardless of H’s length of service at the time of the CEV, there will be the built in assumption that he leaves the service immediately - If, for the sake of argument, he has served 20 years this would mean he had not accrued his full pension and (as an additional disincentive for early leavers) he would not be able to draw his pension until he is 60 (or 65 for service after 2006). 
  • All of this means that the CEV will be dramatically lower than if it was calculated AFTER the magical 22 years’ service. 
  • Acting for W in their divorce, we would all say that H is bound to remain in the Army until his 22 years is completed - making the present CEV calculation unfair. 
  • If the pension is divided on the basis of the CEV provided, W will have a much reduced share compared to what H receives a couple of years later and the increase in the CEV will not be due to post-separation contributions.
*Armed Forces Pension Scheme - as an addition complication, there are several ‘varieties’ of the AFPS scheme in existence - the current scheme is the AFPS 2015 and all members were transferred to this scheme for service after April 2015 - the previous scheme was the AFPS 2005 scheme and the one prior to that was AFPS 1975 scheme. This means that we are currently seeing those with service across all three schemes, adding to the complexity.

The Basics - other factors
One Pension or Many? - £1 may not have a consistent value across the piece!

Acting for H - looking to preserve ’his’ pension
  • will want to restrict sharing to pension accrued during the marriage
  • work on balancing the net CEV between H & W of the ‘shareable’ years
  • offering cash offset on a discounted basis - bear in mind the two types of discount (a) the tax implication of converting pension to cash which is an actuarial calculation as against (b) the “discount for cash” which is more akin to horse trading and very much depends on how much value there is to the receiving party.
Acting for W - looking to achieve “best” share
  • will want to work on the basis of balancing pension income
  • think about other rights lost on divorce - generally applicable to defined benefit schemes - death in service payments, widow’s pension, defined benefit scheme (if forced to take external share).
Impact of sharing on present income
  • If H has pension in payment and W is below pension age then sharing will reduce the overall income until such time as W is of pensionable age.  The court cannot make a deferred pension sharing order, but there are ways around the problem, for those willing to cooperate.
  • The parties agree to enter into a pension sharing order at a future date and agree to be contractually bound by this agreement. 
  • H pays W maintenance until the time the pension share is entered into. 
  • Most importantly, W takes out life insurance on H’s life (just in case he dies before the pension share is implemented)
  • As an alternative, the parties could agree not to apply for DA until after the pension share but, for obvious reasons, this is seldom an attractive option.
Equal Income or Equal Capital?
‘Equalisation of income in retirement’
  • David Salter (sitting as a Deputy High Court Judge) in B v B (Assessment of Assets: Pre-Marital Property) [2012] EWHC 314 (Fam), [2012] 2 FLR 222. - “[Actuarial advice] will be particularly important where the argument is to be advanced that a pension sharing order should be made by reference to equality of projected income rather than equality of capital values, as might well have been appropriate in the present instance. Such evidence of protected income would have been of particular importance here because of the disparity in ages between the parties, where the wife would require a lower percentage to achieve equality of income at, say, age 65.”
‘Equalisation of available pension capital now’
  • Mostyn J (extra judicially) in the forward to Hay, Hess and Lockett, ‘Pensions on Divorce’:- ‘For my part I am firmly in the [equalisation of capital] camp as [this] exercise must surely bring into account the inestimable benefit of actually being alive when the other party is dead! In my book it is an equal outcome for the husband to receive £20,000 annually for 10 years and for his younger wife to receive £10,000 for 20 years. But I acknowledge that my view is not shared by all and we may have to await a decision from a higher court to resolve this issue.’
  • Nicholas Francis QC (sitting as a deputy High Court Judge) in SJ v RA [2014] EWHC 4045 (Fam) at para [83]:- ‘The wife says that there should be a pension sharing order to provide her and the husband with an equal income. Given that the wife is younger and female, this would provide her with a greater share of the combined fund values. I would regard such an approach as unfair and anachronistic in a case where assets exceed the parties' needs. The recent well publicised changes to pension regulations will mean that pension investments are virtually to be treated as bank accounts to people over 55, as these parties are. Why should someone receive more just on the basis of gender? There may have been an explanation when rules required the purchase of an annuity. However, to give the wife more than the husband, on account of either age or gender would seem to me to be unacceptable discrimination unless it is a case which is governed solely by needs. If a person should receive more of a pension fund under the modern rules simply because she (or he in the case of a marriage where the husband is much younger) is likely to live longer, then such an approach would logically extend to all capital assets. Moreover, European Union judgments and rules are rapidly outlawing discrimination on account of gender. In cases where distribution is being made on a basis which is not guided by need it is, in my judgment, incorrect to distribute a pension fund on the basis of equality of income and there is no need for actuarial reports in the overwhelming majority of such cases. I should expect courts to be most reluctant in the future, in bigger money cases, to provide permission for actuarial reports on the issue of how to effect equality of income. Moreover, I suspect that annuities will, in the overwhelming majority of cases, become a thing of the past.’
    • Whilst we will all have noted the explicit reference to ‘bigger money cases’ and cases ‘not guided by need’ - the concept of need is elastic and subject to the interpretation of the DJ on the day. 
    • We are also likely to find this case quoted at us to support the contention that an actuarial report is not needed.
    • If both parties are of similar ages and are relatively young, splitting the pot in two may be fair - but if H is much older he will have much less time for his pension pot to ‘recover’ prior to retirement.
Will this affect how we show pensions on the schedule of assets?
  • Treat them differently - Maskell v Maskell [2001] EWCA Civ 858;
  • Lump them in with current assets - Norris v Norris [2002] EWHC 2996 (Fam); GW v RW (Financial Provision: Departure from Equality) [2003] 2 FLR 108;
  • Sub total current assets then grand total including pensions - Vaughan v Vaughan [2007] EWCA Civ 1085;
  • It all depends on how close in age the parties are to 55 - SJ v RA [2014] EWHC 4045 (Fam).
Pension Freedom
Having raised the spectre of pension reforms… will those over 55 (and the courts) view some pension funds as virtually a bank account?

Defined contribution schemes
  • Take the money now - if you are 55 or older, the first 25% is tax free, the balance is taxable at your marginal rate
  • Keep the pension invested and drawdown over time - again subject to taxation
  • Purchase an annuity - An annuity provides a guaranteed income for life and there will always be those who opt for that security.  There is also the question of tax on drawdown.  After the tax free lump sum the rest will be taxed at the recipient’s marginal rate - anyone choosing the ‘Take the money now’ option may be hit with a very large tax bill. Those listening to Radio 4 over the past few days will also have heard that some of the pension providers have been less than enthusiastic about providing the freedom and flexibility promised by the government.

All very interesting… For those of us thinking about pensions in divorce, the key lesson is to make sure that we know
  • what flexibility is on offer from the scheme in question
  • what will this cost, both in implementation fees and tax
The Law of Unintended Consequences
  • Earmarking orders - check to see that W is protected if H decides to take his pension as cash - any earmarking order which provides W a fixed percentage of the pension income in retirement should be checked to ensure benefits are protected now that H no longer needs to take their pension as an income and could choose to take the lot as cash instead.
  • Selling the family farm - if H has this held in a SIPP and W decides she wants the cash
  • No need for experts now that it is all cash…
Mostyn J in BJ v MJ (Financial Remedy OverseasTrusts) [2011] EWHC 2708 (Fam) at para 75:
“It is common ground that Wife will receive a pension share of 50%.  There will be a pension credit in her favour of just over £650,000. Mr Southgate argues that I should assume W will buy an annuity with her share. I decline to make that assumption. No-one nowadays seriously would think of buying an annuity. Rather, they would likely drawdown on the pension within the prescribed GAD limits. I calculate that some £26,300 would be available annually in this way on the basis that the full 25% tax free element of £162,500 is now taken.”
  • what if the the case I am considering does not have the level of assets that this case had (including a trust valued at £4.3m)
  • income drawdown is not the same as a guaranteed income stream such as an annuity or a defined benefit scheme - investment returns are not guaranteed and it is hard to factor in the effect of inflation
  • what if W lives for longer than the average life expectancy - is it still fair when the fund is exhausted and she has no income?
There will always be cases where W is happy to trade pension share for cash on the basis that she has a (maybe irrational) fixation on retaining the FMH.

We are not actuaries, tax advisers, nor are we IFAs - with the advent of pension freedom there is even more need for our clients to have an understanding of their assets.

If you would like to speak to Kate Miller please contact the EA Law - East Anglian Chambers clerking team on 01473 214481.
 
Kate Miller

Download a copy of these notes here