It is probably accurate to say that Pensions and Divorce is one of the least well understood aspects of the financial settlement proceedings when a couple split.
It has now been 20 years since the Welfare Reform and Pensions Act of 1999 introduced the ability for courts to direct that a pension fund could be transferred to another living individual (remember that normally you can only do this on death!) this was the Pension Sharing Order or PSO.
Hopefully such an order is made when a couple splitting up agree amicably but sadly and I do mean sadly, it is often far more unpleasant and the giving up of something often accumulated over many years can be extremely emotive and letâ€™s face it, painful.
So after so many years it was a welcome event that the former President of the Family Court Division, Sir James Munby, set up a working party to look at the PSO and how it was working in real life and how its use could be improved.
Lets cover some important elements of this highly contentious thingâ€¦â€¦shall we?
How do you value a pension, especially a Defined Benefit one for the purposes of such an order? You do this through the Cash Equivalent (CE) method. Now if you have ever looked at DB transfer this approach is not new and DB pensions give us a Cash Equivalent Transfer Value and this is the same method that is used for a PSO.
All simple so far, yes? Well no actuallyâ€¦..here is our first niggle.
The CE is a snapshot at the time of what the cost would be to provide the member their benefits through the DB scheme, it is not what it would cost on the open market (If you have done a TVAS you will have seen the TVAC!) so simply relying on the CE to give you accurate pension data is rarely going to be fair.
Let me give you an example:
Person 1 has a DB pension with a CE of Â£250,000
Person 2 has a DC pension with a CE of Â£250,000
So they have the same pension benefits, right?
The DB pension will provide a guaranteed income and lump sum and spouses benefits
The DC pension can provide it but it is highly likely that the cost will be much higher than Â£250,000
So there is an in-built inequality right there that makes the PSO potentially unfair.
The trouble is that not often enough are the right advisers engaged in such matters, now I am not a huge fan of actuaries, they are in my opinion expensive and poor value for money (especially when most of their function is carried out by a computer and executed by very, very junior staff and charged at a hugely inflated rate!) but in this case, an actuarial approach is recommended.
I wonder how many people, divorcing, had a CE valuation of the other personâ€™s DB pension and felt they were getting a fair deal? When in reality they just werenâ€™tâ€¦.if the person seeking some of the DB pension is awarded say 10 yearsâ€™ worth of pension it is unlikely that the PSO will give them enough to secure the same benefits as those in the DB scheme, they just donâ€™t work in the same wayâ€¦..
So what can you do?
A more common tool than the PSO used is the Offset.
Here the value of one personâ€™s pension is used to trade off against other, non-pension assets. In essence no pension is sacrificed but a greater share of other assets areâ€¦.
This is often used where â€œneedsâ€ exist, where one party has the children, does not work and requires money far sooner than age 55.
This can be seen often where the person caring for the children retains all the sale proceeds from the family home to enable them to re-home without a mortgage, the other party does not give up any of their pension.
The other party, without the children, typically remains working and can still secure a mortgage, so both parties can be housed.
However, if the accumulated pension assets are significant, then the valuation of them needs to be more detailed and accurate.
It appears from the review of these that people and lawyers are reluctant to look at PSOs and instead try to use Offset instead, largely because they felt that the PSO valuation was too difficult and that negligence suits against lawyers were more likelyâ€¦.
Now the working group, while advocating that specialist advice was necessary, could not agree on who they felt was the right â€œexpertâ€ to engage in this matter.
Personally, I donâ€™t think that an accountant can add any value, nor do I think that a general IFA has the requisite skill or experience to be of much help.
There are a few IFAs that specialise in pensions and divorce and they will have gained their skill by experience but there is no qualification or accreditation that can give you peace of mind to know that your adviser is any good at this, certainly a divorce lawyer may not even be suitable for this as they are not versed or experienced in pensions and most likely never in DB pensions.
So what is the answer for this touchy subject?
There isnâ€™t one and this fact grates with me a little but what I will say is that if you have clients that are going through divorce and the subject of pensions is raised, my advice is to ask as many questions as you can.
Donâ€™t just take what a pension statement says as gospel, question it. If your client is seeking a PSO or an Offset, then make sure what they are being offered really can be said to be â€œequivalentâ€, if there is a DB scheme and the CE value for your client comes back, look at what it could provide through an annuity (this is what you should be doing) and if it canâ€™t provide equivalent benefits ,go back and question the valueâ€¦..
If what the idea of the PSO is, is to give a fair sum to the other party for the purposes of providing equivalent benefits, then make sure that the sum can do it, I think youâ€™ll find in many cases that it is inadequate for what it is claimed to be able to doâ€¦..that is where you as an adviser can add real value.
Divorces can be messy and ugly and arguments over money only serve to add to an already unpleasant situation (to say the least) so if your client is being asked to agree a Pension Sharing Order, it is in your interest to make sure that they are receiving a fair value, that is what it comes down to, fairness.
You can give your client the peace of mind that what they are being offered really is a genuine and fair sum and don't forget, with a PSO they have to take a transfer into a new plan, they cannot remain in the existing scheme, plus in some cases the fee for your advice can be met as part of a settlement (as they have no choice but to take a transfer) so giving your client 100% invested!
So my advice to you is that a PSO does not have to be frightening for either you or your client, it is a normal pension switch and is a necessary part of financial and pension planning when a couple splits.