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Pensions in Ancillary Relief by Tom Tyler

 

PENSIONS IN ANCILLARY RELIEF CASES

 

 

 

DEALING WITH PENSIONS ON DIVORCE

 

• Identify the assets
• Getting the information
• Value the assets
• Decide what to do

 

 

 

(1)  IDENTIFY THE ASSETS

 

Types of pension you are most likely to encounter

 

Final salary occupational pensions

 

• A defined benefit scheme pays out benefits upon retirement that are related to the employee's salary.  These are dieing out in the private sector. They were designed to lock the employee into staying with the company for a long time. Benefits are calculated by reference to both length of service and final salary. Benefits are guaranteed no matter what the state of the economy or the stock market. These schemes are to be found in both private sector and public sector. They are the most valuable pensions you are likely to encounter.

 

Money Purchase Schemes

 

• Money Purchase or Defined Contribution schemes come in two basic types. Occupational schemes and personal pensions. The benefits are calculated by reference to the value of the assets within the fund and the state of the annuity market on retirement.  These are becoming increasingly common with employers closing final salary schemes to new members due to concerns about cost. Benefits are not guaranteed unlike final salary schemes

 

 

 

 

Personal /stakeholder pensions

 

These are the usual pensions available to the self employed. A species of money purchase scheme. Their value is related to the amount of money the scheme member can afford to invest and the value of the schemes assets which is related to the overall performance of the underlying assets. You need to be aware that the usual CETV valuation of personal pensions will often only use the surrender value of the policy. More on valuations below.

 

The State Pension

 

• o The state pension has two components (a) BSP basic state pension, (b) ASP additional state pension that encompasses the old SERPS and new SP2 pension. SERPS is an acronym for the old State Earnings Related Pension. This was a form of contributory state pension that existed from 1978 to 2002 when it was replaced by SP2. It became very popular to opt out of SERPS in the 1980's and invest ones contributions in a personal pension. There were many examples of policies being mis-sold to employees who were often advised that they would be better off than staying with the state scheme. This was sometimes bad advice. However, many employees did opt out and remain opted out of SERPS/SP2.

 

• The point to remember is that many people do still contribute to SP2 and have built up an entitlement that needs to be investigated.SERPS/SP2 only applies to employed people.

 

• Do not underestimate SP2. It is particularly relevant to low earners. It is quite possible for a wife who has had various low paid jobs thorough the marriage to have built up a SP2 entitlement that is greater than her husband who opted out of SERPS SP2 and bought a stakeholder pension or other money purchase scheme. Potentially an employee with maximum SP2 entitlement may have a pension with £125,000 CETV value.

• CETV lump sum of ASP available by filling in From BR20 from www.thepensionservice.gov.uk
• Similarly, Form BR19 will provide a full state pension forecast for both BSP and ASP. www.thepensionservice.gov.uk
• Pension sharing of ASP available
• No costs for sharing ASP

 

 

 

•(2)           GETTING THE INFORMATION:

 

Find out about the parties employment history and pension contributions

 

• o Many people will have had several jobs all of which may have had some pension provision. You cannot assume that the previous pensions have all somehow been passed on down the line and rolled up into the pension scheme of the present employer. Preserved pensions from previous occupations can have a surprisingly high value. Therefore, ensure that Form P is sent to all previous employers.

 

• o Always investigate periods of self employment because during those periods the party concerned may well have contributed to a personal pension of his/her own volition

 

• o Find out about the extent of pre marital contributions. There may have been considerable pre marital contribution to the scheme which may have an effect on the outcome of the case. This sort of contribution could in an appropriate case lead the court to depart from equality in the same way as a party who brings a large capital contribution into the marriage by way of the proceeds of sale of a previous home or an inheritance.

 

• o Likewise substantial post separation contributions could lead you conclude that there should be a departure from equality on these grounds. There might be no reason why a spouse should share in assets created by the sole efforts of the other spouse post separation. See Rossi v Rossi [2006] 2 FLR 192,

 

 

 

Part 2.13 of the Form E. and  Form P.

 

• o A properly completed Form E and Form P ought to provide all the information that is needed and do away with the need for questionnaires in pension cases.

 

• o The revised Form E is the standard form for gathering the most basic information that is required. The form has been simplified and a useful addition is the requirement for a date of calculation of the pension CETV. This is important because the CETV may properly be calculated up to a year prior to any first appointment. Up to date figures are as essential in pension valuations as with other assets. One would not rely on an out of date valuation of the matrimonial home. The same should be true of pensions.

 

• o Form P is a detailed questionnaire interrogating the pension scheme. You will need to use this in cases where the pensions are a significant factor in your case and you are considering a sharing order. Always use it if a sharing order is contemplated. It asks for detailed and technical information that goes way beyond what one would ordinarily see provided in a Form E. Whether the family lawyer is qualified to understand and act upon the information provided in Form P is another matter entirely. For example:

 

• § Part B question 2 in the form enquires as to how the CETV was calculated. Detailed workings would be needed if the answer is to be meaningful

 

• § Part B question 3 asks what benefits are included in the CETV.

 

• § Part B question 5 examines the options available to the recipient of the pension share. It may well be that the outgoing spouse can not remain in the scheme and must transfer out to an inferior money purchase scheme. A vitally important question.

 

• § Part C question 3 addresses under funding. This is a big problem area these days with many private sector pension schemes being under funded.

 

• § The information provided in Parts B and C of Form P would not ordinarily mean very much to most family lawyers. It is the kind of information that an actuary would need to interpret to assist you in deciding on how to deal with the parties pensions. It will usually be necessary to instruct an actuary in a case with any sizeable pension arrangements.

 

 

 

(3)      VALUATION OF PENSION ASSETS

 

• o The prescribed method of valuation of pensions is the CETV (Cash Equivalent Transfer Value.) This is what looks like a lump sum money value that the pension provider will provide upon request from the scheme member. The original purpose of the CETV was to value the bundle of assorted component pension benefits for a scheme member who wanted to transfer his pension to an alternative pension provider. It was never originally intended to value a member's pension for divorce purposes. It was pressed into service as a valuation tool for divorcing scheme members because it was cheap and readily available.

 

• o With Occupational defined benefit pensions the problems in relying on the CETV stem from the fact that the value of the benefits is taken as if the members were leaving the scheme at the time that the CETV is calculated. This is plainly untrue in the vast majority of cases because the CETV is calculated on the basis that the employee leaves the job, certain valuable benefits will not be included with this valuation method. This is usually unfair. It is as if you had a valuation of the former matrimonial home where the valuer has not included the kitchen in the valuation. No client would be happy with a valuation like that. However when it comes to pensions, such a situation is routinely tolerated. I suspect that this is because of a general misunderstanding of the concept of CETV. What is worse, the writer has had an actuary tell him that far less care goes into the production of a CETV to be used for divorce purposes than if an actual transfer out of the scheme was contemplated. It will be recalled that this is the original purpose of CETV.

 

• o Set out below are some examples of why the CETV value undervalues defined benefit pension schemes.

 

 

• Generous early retirement provision will not be included in the CETV. Nor will inflation protection and ill health benefits. This would make the value seem artificially small. Discretionary benefits will seldom be included in the quoted CETV.

 

• Death in service benefits are undervalued because the value of such benefits to an early leaver is negligible compared to those of an employee who stays on.

 

• If a member stays in the scheme, has good prospects and can look forward to good salary increases then the CETV will significantly undervalue the scheme.

 

• A significant number of private sector defined benefit schemes are underfunded. In the longer term this is not a problem, (hopefully) because by law the schemes have to put in place schedules of increased employers contributions to put right the deficit. However, at the time of providing the information to the court, the scheme is permitted to show a reduced CETV. So if the scheme was 30% underfunded, then the CETV would reflect that. However, if the member stays within the employment, the scheme will right itself over time and the member could benefit to the disadvantage of the outgoing spouse.

 

 

Valuation problems with the C.E.T.V. in unfunded statutory schemes

 

• These are among the most valuable pension schemes. They are unfunded in that the employer does not have to set aside assets in advance of the pensions being paid. They are far superior to personal pensions because they are payable out of general taxation as opposed to having to rely on the stock market whose value goes up and down. They contain superior inflation protection that is not available to lesser schemes.

 

• o In general, you need to be very cautious with pension schemes for public sector employees. Be careful with divorces involving the following occupations. These pensions are routinely undervalued by the usual CETV method.

 

• Police Officers
• Teachers
• Civil servants
• Local government employees
• NHS employees
• Army

 

• o Some very surprising valuation evidence can be turned up in cases involving members of the uniformed services. In the case of police officers with long service the CETV balloons in the last couple of years of service leading to a horrendous professional negligence trap for the unwary. Never rely on the simple CETV of a police pension

 

• o Always consider obtaining expert evidence in these sorts of cases. Especially if the pension scheme member is approaching retirement. It is suggested that there would have to be a very good reason why you would not take this course.

 

(4)      DECIDING WHAT TO DO

 

Has the pension been valued appropriately?

 

• In every case where the pensions are a significant feature, consideration must be given to whether the pensions have been valued fairly. This is difficult for the family lawyer to do unaided by an expert. It is very worthwhile to cultivate a competent Actuary who is able to give you an initial view on the pension schemes that you encounter in practice. Always focus on whether the CETV is fair. Consider taking some advice from a pension specialist.

 

• For a fee of just £25 the pension specialists Bradshaw Dixon Moore can provide an online service that is designed to provide an indication of a fair value for a defined benefit scheme. The service will provide a short report that could be used in court at a first appointment.  This sort of report can give you and the court some idea of whether it is worth going down the road of obtaining a bespoke valuation. It's the sort of report that your client could obtain themselves to obtain a view on the true value of their own pension or their spouses pension. www.bradshawdixonmoore.com.

 

• If there is to be a pension share then seeking to argue for an increase in the fair value is not as important as in the case of an offset. If an offset is the preferred solution then depending on who you represent, it may be in your clients interest to assert that the other side's pension asset as having the highest value possible

 

Offsetting or sharing?

 

The search for Equality

 

• In the days before pension sharing, pensions were usually offset against hard assets. Typically the husband would keep his pension in return for losing much of his share in the matrimonial home. The wife would downsize later and hopefully all would be well. However, making worthwhile comparisons between these sorts of different assets is problematic because a future stream of income can not really be compared to cash in the bank on a life for like basis.

 

• White v White brought in notions of equality and this has been emphasised through the decisions in McFarlane v McFarlane and Miller v Miller [2006] UKHL 24. We are now engaged in a search for the fairest way to share the matrimonial acquest. Now after the House of Lords decision in Charman v Charman [2007] EWCA Civ 503 the state of the law is that equality is in there at the beginning of the decision making process not just as a yardstick by which the result is to be judged. Sharing the various types of assets equally certainly sounds like it is fair.

 

• With the advent of pension sharing and the above decisions it seems as if offsetting is becoming more unusual. Many advisors are preoccupied with a mathematical equality sometimes at the expense of a sensible outcome. Sharing is certainly seen as a safe bet and it is less troublesome for legal advisors. It certainly requires less imagination to implement a share than to arrive at a possibly more creative offsetting solution. When the value of the assets would not allow for an offsetting solution then sharing is often the only practical answer but it can be a blunt instrument.  Whether sharing is always an appropriate solution when there are sufficient assets that could be offset shall be discussed further.

 

Pension sharing pitfalls

 

Problems with sharing Local government schemes and obtaining inferior benefits

 

• Many local government pension schemes have generous pension arrangements for long standing employees. Typically the scheme will permit the outgoing spouse to join the scheme, but will provide her with inferior benefits. For example there will ordinarily be no widows or dependents benefits so the scheme is of a lesser value.  If your client is at all likely to remarry then this is an important lost benefit. However not all local authorities make their position clear. It's always well worth having a look at their pension scheme websites for details. Some are more informative than others. 

 

 

Problems with Private Sector schemes.

 

• Defined benefit (DB) schemes are the pensions crème de la crème. This because DB schemes have "promises" to pay a specific benefit in the future. This is usually defined in relation to the earnings. Whatever happens to annuity rates and investment returns, the promise has to be met.  Also DB schemes usually have some measure of inflation protection on the benefits, both in deferment and payment. All these bells-and-whistles cost money. Long serving employees are the most likely to be members of these kinds of schemes

 

• However, new employees who join these schemes are often not so generously treated. They have to sign up to Defined Contribution (DC) schemes. The DC contributions will be invested in the scheme and will hopefully increase in value but this is totally dependent upon the investment performance of the underlying assets. If the investment performance is poor, hard luck, the employer will not offer to put more money in. Finally, when it comes to retirement the DC member effectively has to go to the market and buy an annuity (although some DC schemes may provide the annuity in-house). I do not believe that it is even possible to achieve the sort of inflation proofing in the general annuity market that is provided by many (particularly public sector) DB schemes

 

• The point here is that on a pension sharing order, many pension schemes permit the outgoing spouse to join the scheme but will not give her Defined Benefits. She will be forced to join the inferior DC scheme. She may not even be able to remain in the scheme at all and have to take her pension credit and go and invest it in an inferior personal pension. On a worst case scenario there is the potential for the share of the wife to be calculated as a percentage of an artificially low CETV of the husband's defined benefit scheme, then she would have to take that undervalued portion of pension credit and go and invest it in a money purchase pension which is likely to be inferior. The husband of course would continue to be a member of his superior final salary scheme, perhaps with all of its benefits. A somewhat unfair outcome which could be avoided by using a competent expert.

 

Pension sharing potentially wasteful of valuable assets

 

• Always make sure that you know what kind of pension the member and spouse will receive upon a pension share. Many schemes will pay substantially reduced benefits to the departing spouse, and sometimes to both spouses on a pension share. You cannot just assume that an equal share of CETV will give the spouse an equal share of the pension income.

 

• I recall one case where the unshared pension was set to provide £30,000 P/A to the scheme member upon retirement at age 60. An actuary was instructed to report on how parity of retirement income might be reached. Surprisingly, on the operation of a pension sharing order the income to both parties only amounted to £9,000 P/A each upon retirement at 60. The reason for this was because the internal rules of the scheme provided that upon a pension sharing order there would be a loss of the member's advantageous guaranteed annuity. Needless to say this surprising fact would have remained undiscovered by the parties until retirement had the actuary not been instructed. This situation is by no means unusual. It's a case of the Pension sharing order killing the goose that laid the golden egg.

 

• Clearly, pension sharing has the potential to be very costly to the parties in terms of assets that are lost by reason of a pension sharing order. The reason for this is that cash strapped pension schemes are keen to save money where they can. One way of doing it is to slash benefits to divorcing members when a pension share is implemented. You really need to pay attention to this because this kind of danger is always going to be hidden away in the small print.

 

• The writer has some deep reservations on pension sharing orders in circumstances where substantial amounts of asset value would be lost.  It is suggested that there may be a real need for full financial advice being provided to both of the parties (including their solicitors) on the consequences of the pension sharing order - attitude to risk for the ex-spouse will obviously be important if she has to leave the scheme and invest in a personal pension.

 

• Part of the problem is that the parties involved will see their solicitors as "men of business" able to provide them with a proper well rounded and complete service on divorce.  They may not understand that their lawyers are not able to give the financial advice necessary.  It appears to me that any transfer from a defined benefit scheme needs careful handling.  I am also concerned that the decision to get a pension sharing order may be made too early in the process before this advice or care can be taken.

 

• It is suggested that you should always be in a position to be able to advise your client of the benefits that will be offered if a pension sharing order is being actively considered. You simply must not put yourself in a position of advising on a pension share in ignorance of internal rules that would wreck any future benefits to the parties.

 

 

Choose the right scheme to share

 

• It follows from the foregoing that in cases where there is more than one scheme, choosing correctly the scheme to share is vitally important in terms of the income that is derived. Choice of which scheme to share can have a radical effect on the outcome upon retirement because of the internal structures and rules of a particular pension scheme. Knowing which scheme to share is not in the writers view something that a lawyer is ordinarily qualified to advise upon. You will need expert advice on this question

 

• Remember to factor in the costs of sharing and who should bear the costs. If the order is silent as to costs then it is usually the transferor who will pay. If there are several pensions that could be shared then sharing them all would be expensive in terms of costs. Perhaps only one needs to be shared. Less sharing will keep costs down

 

 

 

Offsetting

 

• Offsetting is when one party takes additional hard assets in return for less pension. Offsetting seems to becoming less frequent now that sharing is possible. There several reasons for this. One is the fact that sharing the pension is a safe bet. Despite the fact it can be very wasteful of assets as I have described above. However, that might not be widely known. There is a lot of anxiety about offsetting. This is understandable. There is no accepted methodology of how to offset. The courts are reluctant to offer any assistance therefore advisors shy away from offsetting if the pension assets are of any size.

 

• I think that it is a shame that offsetting is not more widely used. If the husband has a healthy pension that would be seriously de valued by a sharing order, then there must be a strong argument for pausing to see if there was not an alternative way of distributing the wealth that has been created by the marriage. If the parties are fortunate then there may be other hard assets that could be given to the wife to make up for the lack of a share of the pension. If a good quality pension was to be retained by the husband in its entirety then the wife would need to be fully advised on what she was foregoing and what an appropriate balance of hard assets might be.

 

• An actuary can always give a view on an appropriate approach to the question of offsetting in individual circumstances. One of the reasons that offsetting causes so many headaches is that the courts are preoccupied with the search for equality. Advisors understandably interpret this as a need to advise client's on the basis of a mathematical approach to equality of assets. It is suggested that this is not the only approach that is permissible. It is hard to compare immediate ownership of a £50,000 holiday home to a pension worth £100 p/week in 10 years time. Every client approaches divorce with a different set of priorities.

 

• So much depends on what utility the individual client attaches to the asset in question. For some, a clean break is worth almost any price. For others preservation of their pension is paramount and they will give up a lot to achieve that. For others, retention of their home is their only desire. I would venture to suggest that rather than always striving for mathematical equality a more productive approach might be to engage in maximising the parties' assets and focussing more on the clients' needs and priorities. As long as clients are fully advised of the consequences of their decisions then offsetting can be a perfectly acceptable and sensible solution in an appropriate case.

 

 

What to bear in mind when offsetting

 

• Any liquid assets retained will usually be free of tax. This is in contrast to pension income which in terms of income paid to the pensioner is usually expressed as gross income. This will effectively mean that the pension value will look artificially high because anything up to 40% of that money will be payable in tax.

 

• The cash sum is immediately acquired rather than being postponed until a later date as is the case with pension income. So bear in mind the discount for accelerated receipt

 

• The pension scheme member might die and therefore he will never get the pension income. This is in contrast to the recipient of cash.

 

•  If you are considering offsetting then there is a lot to be said for seeking actuarial advice on how much should be offset to achieve a fair outcome. Actuaries can usually advise on offsetting if they are asked to do so and in the absence of any approved way of going about this task, it is suggested that it must be the safest course of conduct for all concerned.

 

• Have the client's priorities uppermost in your mind, as well as a fractional approach to the concept of equality

 

 

CONCLUSIONS

 

In every case, consider the following:

 

• Make sure you have found all of the assets including previous pensions and state schemes.

 

• Ensure the completed Forms P are available if an offset or sharing order is on the cards.

 

• Treat CETV values with a caution. Make sure it is up to date. With a final salary pension always remember that you need to find a fair value.

 

• Decide if your case is going to be one for offsetting or pension sharing. Try and preserve as much of the value of the pension as possible.

 

• If there is to be a sharing order then the golden rule must be to determine what the result of a pension share will be for the parties and to ensure that the client is fully aware of it.

 

• Always consider obtaining expert advice and guidance at an early stage.

 

 

TOM TYLER

4 Brick Court

Temple

London EC4Y 9AD

 

tom.tyler@4bc.co.uk

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Related Barrister or Author:

Tom Tyler