Ep. 23 - Dealing with pensions on divorce

Tim: In this episode, we're going to look at finances on divorce with a specific focus on cases that involve pensions. We're joined today by David Hickmott, a Principal Associate in our London team. David is a specialist family lawyer advising on complex financial matters, which often include pensions. Thanks for joining us, David.

David: Hi, everybody. Very nice to be here.

Jen: Before we get on to our questions for David, let's just briefly look at what we mean when we're talking about pensions and explain some of the terminology we might use in today's episode. Pensions are one area where there's lots of different descriptions and different terminology, so let's try and bust some of those complicated bits to begin with.

For a lot of people, a key distinction might be whether they have a workplace pension or a private pension. And people may be familiar with terms like salary sacrifice or final salary schemes. As family lawyers, the main way we distinguish pensions is based on the following main two types of pensions. They're either a defined benefit pension or a defined contribution pension.

Tim: So, a defined benefit scheme are ones like NHS pensions, teachers' pensions, or armed forces, where the focus is on the income or the benefits you're going to get on retirement. These are calculated often by looking at your salary and how long you've been employed with that organisation.

In contrast, a defined contribution pension is based on what has been put into the pension. So, the fund that's been built up through your contributions throughout your working career. And what that means is that when you retire, the amount you have available will be based on how much has been paid into that pension and any investment return that has happened over the time of holding the pension.

You can have defined contribution schemes with your employer, or they can be set up privately. You can also have your employer making contributions into your defined contribution scheme as well as you, which is often where you get a percentage match where the employee might match 2% if you put 2% in, for example. The value of the pot can go up and down depending on investment over the life of the pension.

Jen: Whichever type of pension you have as part of the disclosure that you're asked to provide at the start of a divorce, you'll need to produce the CETV for your pension. That stands for the cash equivalent transfer value. That's something that's usually quite easy to obtain for a defined contribution scheme, but it might take a bit longer to get for a defined benefit scheme because of the calculations that have to be carried out.

So if you're keen to press on with things, knowing that you might need to get that information to begin with, is a useful point to start at. The other point just to mention is that to keep matters simple for today's podcast, we're going to be talking about pensions that are based in the UK. Things can get a lot more complicated if you have overseas pensions, but that may well be a topic for a podcast another day.

Tim: So, with that terminology in mind, let's look at how cases involving pensions might be dealt with on divorce.

Jen: So, David, can you tell us just generally how pensions might actually come up in a divorce case?

David: Well, a lot of people, if not most people have some form of pension and they're an asset like any other asset. So, if they've been built up at least in part during the marriage, then potentially they can be shared. And they can also be relevant to meeting parties' needs, which are the sort of two main strands of the financial considerations.

The key factor with pensions, which is different to other assets, is that they're not immediately available capital. It's not cash in the bank. They usually have a future value in terms of the lump sum that you can draw down and the income that you can get in retirement. As you guys have said, there's lots of different types of pensions. So always lots of things to consider when you see a pension on the asset schedule.

Tim: I think it would be helpful at the start to set out what powers the court have when it comes to pensions because usually, I think people think of them as quite inflexible and as you say something that's for the future rather than something they need to deal with at the moment.

David: Yes, the most common form of order that's made in relation to pensions is what's called a Pension Sharing Order, sometimes called a PSO, if we're feeling lazy. And that is when the court allocates a percentage of somebody's pension to the other spouse. And that's a percentage based on the cash equivalent value, which Jen has already mentioned. So that's not received as cash in hand. You don't get 50% of the value.

You get it as a pension credit, which means the receiving spouse will either have a new pot created within the same scheme, or it could be transferred out to an existing pot or an existing pension to increase it. And that's generally, but not always done on the basis of how much pension does each party need to have in order to have equality of income at the date of retirement.

You can also divide up based on capital, but that's perhaps less common. The other type of order that you can have, is what's called a Pension Attachment Order. That's much more rare. And that is where the court basically says that a percentage of benefits, whether that's a lump sum benefit or an income benefit to be transferred to the receiving spouse when those benefits become payable. So rather than saying have 50% of this pension now for use in the future, you say, when that pension starts to pay off and I get £100 a month, you will receive £50 of that.

And other people look at offsetting as well. And offsetting is where you consider what the value of the pension is, and you basically trade it off against other assets. So instead of taking 50% of my pension, I'll give you some extra cash instead. That can have some complexities around it, which I'm sure will come onto in terms of valuations.

Tim: Great. And just, I suppose, picking up on the pension attachment order, I think it's fair to say that that is used, as you say, far less frequently. Because of the risks I think that come along with it, it's reliant upon the person with the pension still being alive at the point that they are able to claim the pension.

And they, let's say they retired at sixty-five and then they passed away at seventy. Pension then dies with them. And the person that was receiving the benefit then has nothing. Whereas with a pension share, the pension credit is removed completely and put into the pension in the name of the person.

So, it's then theirs, isn't it? And they can make decisions independently. They can invest it in whatever pension they would like. They can buy the annuity. They can do whatever they want. They have that flexibility. They're not reliant upon the original pension holder.

David:Yeah, exactly. And effectively a pension attachment order isn't a clean break. As you say, you continue to be tied to that person and their decisions and how their life spans out. Which, you know, it's not what the court is trying to achieve, if possible, and not what people want. People want to have, know what they've got in their pot and deal with it, how they see fit. Which is, as you say, I think probably why pension sharing orders are so much more common now.

Jen: And I think that also overlaps a little bit in terms of what clients' priorities are as part of a divorce and how they want their pensions to be considered as part of a divorce. I definitely know clients who come in with very strong views about protecting their own pension if they are the one that's got the more valuable pension. I guess you see that probably as much as I do. I mean, what are clients' priorities when they're coming to talk to you about pensions?

David: I totally agree. It really depends on a case by case basis. Some clients, their pension is something they've built up potentially over their entire working life. And they really want to preserve it. And then they want to look at things like offsetting, even sometimes if that's not, you know, makes the most commercial sense, but there can be a real sort of emotional feeling about something you've built up in your career.

For younger couples in particular, people like myself I'd like to think, they might be a bit more relaxed about how pensions are dealt with because the reality is if you've got thirty years of working life ahead of you, retirement can, for all of us, can seem like a really distant prospect and therefore you're not going to be as concerned about that as you are going to be concerned about having cash in the bank to put into a property or to meet immediate needs.

I mean, the key thing ultimately is ensuring that clients understand how things can be dealt with fairly. And again, going back to the offsetting point, it's a really good example of ensuring that the right weight and value is attached. So, if somebody wants to protect their pension and their pension is worth a million pounds, they shouldn't be giving out a million pounds of cash because, you know, it's not like for like.

Cash has more immediate value than pensions. And so it's… That valuation aspect can be one of the trickiest elements because pensions are administered and they're valued in a really complex way.

Tim: And I suppose for the purposes of avoiding this becoming a three-hour podcast, we'll stay relatively high level, but talking about valuations, talking about offsetting, I suppose that leads us on to trying to get clients the best information that they can, so they can make these decisions in an informed way. And that would usually involve an expert.

So, can you just talk a bit about when experts might get involved, who those experts would usually be and whether it's, is it mandatory or is it advisable? Just talk to us about pension experts.

David: I mean, first of all, I'm not sure why you don't want a three-hour podcast, but that's, that's okay. Yeah, talking about, we refer to PODE’S, which is P-O-D-E, which is a Pension on Divorce Expert. And they are the people that get instructed to prepare reports about how to deal with pensions. And they can be actuaries, normally they are, but they can also be independent financial advisors who have certain qualifications.

And generally what you're doing when you're instructing a PODE is saying, here's the pension information. Can you calculate what pension share we need to achieve a particular outcome? So, equality of income on retirement or what pension share is required or what offsetting figure is required to not have a pension share.

Because they're such complex questions and calculations, a lot of cases require that expert evidence. And if there's sort of any degree of uncertainty, it's probably sensible to err on the side of caution and get that expert evidence.

That being said, not every case requires it. If you have two parties who are of a similar age and they have very similar pensions, and there's no sort of hidden extras like guaranteed annuity receipts or anything like that. It can be appropriate to say, well, we're just going to do a balancing exercise based on the capital figure. To be confident about that, though, you have to understand what the benefits are built into the pension.

And I think, you know, probably myself included, you don't necessarily know, particularly with occupational schemes, you pay in, you don't necessarily think about the finer details. So, if you're, if people are considering not having a pension expert, you know, a paid report. They might want to first get some even preliminary advice from a financial advisor or their pension person, whoever that may be, just to make sure they really understand what the benefits are.

Again, another indicator which might suggest you don't need a PODE report is going back to the very young couple. So, if you've got thirty, forty years of working life ahead of you, even if there are small inequalities, it might be appropriate to take a view that they're going to be ironed out in the course of people continuing to contribute to pensions. But it's not an easy call with pensions because there are so many complexities there. There are so many pitfalls. So, some advice is nearly always required, even if that's preliminary financial advice just so you know what you’re dealing with.

Jen: I would echo that point completely and I think sometimes it can be helpful for clients to think about the proportionality of the costs that might come with getting legal advice. As you say, for a younger couple where, you know, lots may well change between now and retirement, there's possibly only a little difference between their schemes. Again, the cost of a pension report might seem off-putting.

But actually, the closer you get to the retirement, the potentially more complex and more valuable your pensions. Actually, spending two or three thousand pounds, it’s a lot of money, but actually that is what is going to safeguard your income in retirement, which, you know, with people living longer may well be twenty, thirty years’ worth of income. So it's an important point to get right, I think.

David: Yeah, and if you're, as you say, if you're dealing with young people, then, you know, you might take a view. But as you say, closer to retirement, that indicates you want to report. And if there's any complexities around the type of pension, so if they're defined benefit pensions or public sector pensions which have particular complexities then you really do need to think that actually the paid report is probably money well spent because the valuations are so tricky. You're not going to get it right just by doing it on the back of the envelope.

Tim: So it sounds like we're saying start with the assumption that you do need some assistance and then see if you fall into a smaller category of people that potentially don't rather than assuming you don't need any help.

And I think just to add to the point, you were both saying is that sometimes separation can be a good time just to actually revisit what you're doing with your pension, what the strategy is, and take some advice more generally because it tends to be one of those things that sits there and people don't think about that much during the earlier and middle period of their career. So I think that there's always that opportunity as well.

Jen: So we're clear that we're potentially having clients who are getting some input from a pension on divorce expert. Is it then the case that they're going to be working with their lawyers to negotiate a settlement or is there going to be the option to then potentially perhaps take that PODE report into mediation, for example?

David: Yeah, absolutely. You know, mediators are going to be quite used to dealing with pensions, I think. Depending on the circumstances, as Tim has said, it's likely that you're going to need that PODE advice, that expert report.

But that doesn't mean... Once you have the answers, once you have the information, it can't be dealt with in the context of a mediation or an arbitration, particularly if you're, if you're doing any kind of non-court dispute resolution, with lawyers assisting or lawyers in the background, then it's a really sensible way to deal with it.

Tim: I think one of the advantages that I've seen in mediation is that you can have a PODE or a financial advisor come into the mediation session with both the parties and give, certainly, the information we were talking about at the start of the podcast about what are the different types of pensions, what are the different benefits, are there any benefits that aren't obvious such as index linking or guaranteed annuities.

And so they can help with the disclosure process. And then also, if the party starts to talk about offsetting or sharing, then that information can be provided to both parties at the same time, which I think is quite a helpful way to deal with it.

But whatever process you're using, whether it's mediation, arbitration, lawyers, even just discussing this directly between the parties, it's important that people understand the assets that they're talking about so they understand the pension. So, this advice, I would say, is needed regardless of what process you're using.

Jen: So, bringing all of that together, I think we've touched a bit on there about the disclosure side of things, making sure that you're coming at it from an informed perspective. But what would you say, David, to someone who's thinking about a divorce where there are pensions involved?

David: The main thing is that it's important to deal with this properly because it can be really complicated, but pensions can also be incredibly valuable. For some people, it's the largest asset they have. They've been paying in their whole life. You can imagine that. So you need to see solicitors like Mills & Reeve who have this kind of specialism who can talk you through what you need and help you understand what the options are.

As we've said... Getting some preliminary advice from your financial advisor, if you have one, can be a really sensible step because not everybody's necessarily aware of what their pension is, what it's doing, what it involves. And even when it looks simple, there can be complexities around sort of benefits that aren't necessarily obvious. So, get that advice, get it early, understand what you're dealing with.

The other point about getting it early is it can take a very long time. The reality is, particularly if you're dealing with public sector pension schemes, they have more work than they can kind of cope with at the moment, so getting information out of pension providers, getting the detail that you need for a PODE report can add weeks, if not longer, to a timetable.

Which is a not very attractive thought and just makes it all the more important for people to start gathering this information, start sending their request forms as soon as possible to get that process started. What you don't want to do is not think about it, feel like you're close to a settlement and then have to be writing to a pension provider that says, yes, we'll get back to you in twelve weeks.

So that would be my, that would be my key advice is get out the gate early.

Tim: Brilliant. So, get out of the gate early, get advice early, and then you can go into the discussions in an informed way, understanding the true value of the pensions.

Jen: Thank you for joining us, David. You've really helped to break down what is a very complicated topic into some manageable chunks that hopefully people can digest and take away.

We'll also include in the podcast notes some links to some of the useful blogs that we have on our Mills and Reeve website.

David: Thanks both. It's been an absolute pleasure.