Nicholas Donnithorne looks at a case of earmarking in practice and
the draft bill on splitting pensions
How best to deal with pensions on divorce was one
of those issues which spent many years on the "too difficult" pile
of Ministers. However, they were forced to confront the issue
during the debate on the Pensions Act 1995 and since then much
effort has been put into getting the details right. The Pensions
Act introduced an intermediate stage, pensions earmarking. Now we
have a Bill, unusually published in draft form, to achieve the
probably more satisfactory solution of pension splitting.
Earmarking - TvT
Many schemes have now seen at least a few
earmarking orders, but most of these have been as a result of
consent orders - where the divorcing couple have, however
reluctantly, come to an agreement.
It is only with the case of TvT earlier this year
that the Courts' thinking on contested hearings can start to be
judged. It also illustrates some of the problems with
Mr and Mrs T had been married for fourteen and a
half years before separating. They had no children. Mrs T had
worked for the first half of the marriage but had given up her job
some seven years before the separation. Mr T was an executive
director of the derivatives and futures department of a bank.
Mrs T's claim
Mrs T asked for an order containing three
- the lump sum of four times Mr T's salary which would arise if
he died in service;
- a lump sum if he survived to retirement; and
- a periodical pension at a rate of almost £39,000 on his
Valuation of pension rights
Although the relevant legislation states that
pension benefits are to be valued on the basis of the member's cash
equivalent, the one thing on which both sides' actuaries agreed was
that this was not appropriate in this case. Uncertainties over the
operation of the Pensions Act and the Minimum Funding Requirement
meant that the trustees could not give a transfer value. The judge
accepted that this would not have helped in any event in this
The Court accepted the more traditional valuation
method of considering the prospective pension as a stream of
income. The actuaries had to establish what benefits the couple
would have been entitled to, discount this to give a current value
and then apply discounts to take into account the possibility that
either or both of them would die (or in Mrs T's case re-marry)
before receiving the benefits.
The Court agreed that the benefits which should be
valued included the death in service lump sum, the widow's pension
and any balance of the five year pension guarantee. More
interestingly, the Court also agreed to value and take into
consideration 50% of Mr T's pension from the date of his
retirement, rather than merely from when the widow's pension
commenced; this was counted as part of the pension benefits lost by
Mrs T on the divorce.
Mrs T's barrister argued that the earmarking
provisions of the Pensions Act 1995 required the Court to treat
pension rights separately from other assets and to compensate for
their loss even where the other assets were sufficient to provide
the normal benchmark for provision on divorce - a former spouse's
reasonable needs. The judge rejected this view "unhesitatingly".
Although the Pensions Act requires the Court to take pension rights
into account when considering the assets of the marriage, the
powers involved merely expand the options available to deal with
the assets of the marriage. On this basis the Court can quite
properly consider that the other arrangements it has made are
The nature of an earmarking order was also
considered. The judge confirmed that it is like any other
maintenance order in that it ends on remarriage. It is also subject
to either party's right to seek a variation of the order at any
time during the paying spouse's lifetime.
At the time of the divorce, Mr T was only 46 years
old. The judge took the view that dealing in detail with
circumstances which would not occur until some 14 years later was
not realistic. Even then Mr T could delay his actual retirement and
so frustrate any earmarking order for up to 15 more years. It would
be more appropriate to make any such order much nearer to Mr T's
retirement date. At the time the Court could also consider how, if
at all, the start of earmarked pension payments should reduce any
periodical payment order still in existence.
The death in service lump sum was viewed
differently. The judge accepted that it provided a form of
insurance for Mrs T against Mr T's early death and the consequent
loss of her future pension. He ordered the trustees to make a
payment of ten times the annual level of maintenance at the time of
death (or the whole of the lump sum, if smaller) out of the death
in service lump sum.
This might have been a more appropriate case for
the pension splitting powers yet to come. The judge foresaw "a
number of potential pitfalls, disadvantages, complications and
distractions" if he were to direct an order for deferred periodical
payments. In this case there was no evidence that normal
maintenance orders would be flouted. The couple were a long way
from retirement ages which introduced a lot of uncertainty to any
order the court might make. Perhaps of greatest importance was the
fact that the assets of the marriage and Mr T's salary level meant
that the judge had freedom to broker a "fair" deal without breaking
up the pension rights.
Pensions earmarking will remain a valuable option
for those who are close to retirement. However, this case shows
that Courts will, quite sensibly, be loath to use earmarking in
straightforward cases where there is no obvious advantage in the
complication it brings. Common sense decisions like this will save
time and effort for pension scheme administrators and, as costs
would be borne by reduction of benefits, maintain the value of
benefits provided to members.
The Government has now published a consultation
paper and draft Bill for the other method of dealing with pensions
on divorce - pension splitting, or as it is now described, "pension
Under the Bill, pension rights will be treated like
any other asset so that the whole or a proportion of their value
can be transferred from one spouse to the other as part of the
financial horse trading on divorce or annulment. Pension sharing
will simply be one of many options facing divorcing couples. It
will still be possible to offset pension rights against other
matrimonial assets or to use the earmarking orders under the
Pensions Act 1995.
What pension rights will be covered?
The legislation is very wide-ranging; it covers
occupational pension schemes, personal pension schemes, retirement
annuity contracts and other annuities and pension policies. Even
SERPS is covered. The basic state flat-rate pension is about the
only pension arrangement not potentially within the scope of a
pension sharing order.
How will it work?
Pension sharing is far more consistent with the
"clean break principle" which the Courts have striven towards. The
problem with earmarking is that it is a parasitic right; the
ex-spouse's pension rights depend on when the member begins to draw
a pension (which, as noted in TvT, the member can postpone for many
years) and, worst of all, the pension dies with the member.
When will it apply?
Pension sharing will only apply in relation to
proceedings for divorce or annulment which begin after the new
arrangements come into force.
A member's pension rights will become subject to a
"debit" and the former spouse will become entitled to a pension
"credit" equal to the amount of the debit. The amount of the debit
will (in England and Wales) be a percentage of the cash equivalent
of the member's pension rights accrued up to the day immediately
before the day on which the court order takes effect, and will be
specified in the pension sharing order.
Pension sharing can apply to a deferred, active or
pensioner member. A survivor's or dependant's pension for which the
member may have qualified (e.g. following the death of a spouse
from a previous marriage) cannot be subject to pension sharing.
For members of a money purchase scheme, the debit
will normally take the form of a once and for all reduction of a
percentage of the money in the member's "pot", so if the order
provides that the member's pension rights are subject to a debit of
30% of the cash equivalent, that amount will be taken from the pot
and be available for the former spouse.
As usual, the position is more complicated for
final salary schemes. The following example is provided in the
notes to the Bill:
Deferred pension at date of divorce:
20/60ths x £30,000 = £10,000
Cash equivalent for pension sharing calculated by actuary:
Pension debit ordered by Court (40% of cash equivalent):
At retirement the member's benefit will be as follows:
- the member retires at age 60 after 30 years service with a
salary of £48,000
- full pension entitlement (ignoring debit) 30/60ths x £48,000 =
- the actuary calculates that the deferred pension of £4,000
(i.e. 40% of the deferred pension of £10,000 at date of order) is
equivalent to a pension of £6,000 a year at retirement. This is
known as the "negative deferred pension"
- the member's actual pension will be £24,000 minus £6,000 =
On the winding up of an occupational pension scheme
the normal statutory priorities will apply so that if a spouse with
a pension credit is actually drawing a pension from the scheme they
will get a higher priority than one who has not begun drawing a
Inevitably, pension sharing will give rise to
additional administration. Pension schemes will be able to recover
reasonable administrative costs from the divorcing couple e.g.
valuation of rights and the costs of discharging the liability for
the pension credit and reduction of the member's benefit. These can
be paid in cash or as a pension deduction. Pension schemes will not
be obliged to impose such charges and the Government does not
intend to impose charges in connection with SERPS rights. However,
the general cost to a scheme of keeping a new class of deferred
pensioners will not be recoverable.
Provided the pension scheme is funded, the
ex-spouse will be permitted to transfer his or her newly acquired
rights to another scheme. This may be fine where the ex-spouse
becomes a member of another occupational scheme willing to accept
the transfer, but the prospect of a small transfer payment to a
personal pension may not prove an attractive proposition in
relation to the charges likely to be levied. The pension scheme
will, however, be able to buy-out ex-spouses' benefits if it wants
to. Schemes will have to formulate a policy on whether or not to
retain such benefits and incorporate this into scheme rules.
OPRA will be given power to impose penalties where
schemes have not complied with pension sharing orders within four
months of receiving the order and accompanying details.
Clearly pension sharing is a good idea but the
implementation of yet another set of complicated administrative
procedures and yet more jargon will add to the administrator's and
ultimately the trustees' burden.