October 2020

Pension benefits in divorce or dissolution settlements often represent the largest capital asset after the family home. This newsletter illustrates how settlement proposals may be enhanced after considering the types of pension scheme concerned, the bases of valuation and the circumstances of the parties.

The Court can deal with pensions in three ways on divorce or on the dissolution of a civil partnership. The value of pension rights may be offset against other assets, e.g. one party retains the pension rights but the other party takes a greater share of the equity in the family home, or pension rights may be divided by way of pension attachment or pension sharing orders. Attachment orders result in part of the pension member’s benefits being payable when the other party chooses to take the pension but there is no legal transfer of ownership. Alternatively, pension sharing orders result in a legal transfer of part of one party’s pension benefits so that the other party acquires his or her own pension fund.

Although the valuation of pension rights is primarily a matter for actuaries, forensic accountants need to take account of valuations and analyse available assets in advising on settlement proposals.

The Basis of Valuation

A Cash Equivalent Transfer Value (CETV) is the cash value placed on a member’s pension benefits, representing the amount available to transfer to an alternative plan in exchange for the member giving up rights under the scheme. It is the prescribed method of valuing pension rights in divorce cases but the true value of the benefits may be greater if the member is still in pensionable service. For example, CETVs can ignore ill-health benefits and specific pension scheme features, e.g. there are public sector schemes in which it is possible to retire earlier than the “normal retirement” ages generally implicit in calculating the CETV. Such aspects are particularly applicable to final-salary schemes.

Example Relating to Final-Salary Scheme to Optimise Settlement Proposals

One party often has a greater share of the assets so that there needs to be a transfer of assets to the other party. If such assets include a significant proportion relating to pension rights arising from a final-salary scheme and the other party has earned income from which future contributions can be made to an existing or new pension scheme, it may be preferable for the following reasons for both parties to opt for offsetting with the result that assets other than pension rights are transferred:

  1. the asset-rich party benefits because assets valued at, say, £50,000 transferred to the other party are less valuable than a CETV of £50,000 relating to a final-salary scheme given that this amount undervalues the “fair” value of the pension rights involved; and
  2. on the basis of the illustrative sums above, the recipient party benefits because he or she could invest £50,000 in a pension fund, possibly over more than one year, with the net cost of such an investment being £30,000 if tax relief is obtained at the higher rate of 40%.

Example Relating to Money Purchase Scheme to Optimise Settlement Proposals

In situations in which the CETV may be more representative of the fair value of pension rights, e.g. for a money purchase scheme, if the asset-rich party is willing to have his or her pension benefits subject to an attachment or pension sharing order but also able to make future pension contributions from earned income, there may be benefits for both parties for the following reasons:

  1. the receipt of a share of the pension rights either now or in the future is a “fair” reflection of the benefits available to the party whose pension rights are being reduced; and
  2. on the basis that pension benefits amounting to, say, £50,000 are subject to transfer, the party whose pension rights are being reduced could invest £50,000 in a pension fund, possibly over more than one year, with the net cost of such an investment being £30,000 if tax relief is obtained at the higher rate of 40%, i.e. the net loss would be less than the sum of £50,000 transferred to the other party in respect of pension rights.

Conclusions

It is important to recognise that obtaining valuations of pension rights represents the beginning of a process which can lead to optimal settlement proposals for one or both parties. Advice from expert accountants in such situations may be valuable for the instructing party.

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The information contained in our Newsletters is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Newsletters were published in recent years, the information contained in them may not be applicable at the current time.