While the number of divorces in England and Wales has been trending downwards since the early 1990s, over half a million people got divorced in the last five years, which is clearly still a significant amount. People are also divorcing later in life. In 1999, the mean age at divorce for a man was 41, for a woman 38. Twenty years later, and it’s 48 and 45.
Given the volume of divorces and the age profile of the divorcing parties, financial advisers are increasingly likely to encounter clients going through this process. And whether it’s an existing client or a new client, there is clear value that an adviser can bring over the short, medium and long term.
In this article, we’re focusing on the short-term, in particular the process of implementing a pension sharing order (PSO). Specifically, we’ll be looking at how the process works in a money purchase pension scheme for a PSO granted in England and Wales.
What is a pension sharing order?
At a high level, a PSO is a way of sharing pension funds with a former spouse or civil partner following a divorce. Under current legislation it’s the only way a pension can be given to another person during the member’s lifetime (at least without incurring significant tax charges).
In practice, it forms part of the main divorce order, and the details are included in an annex to the order, the key detail being how much of the pension scheme is to be shared.
It’s important to note that in England and Wales this must be expressed as a percentage, and it’s a percentage of the whole scheme. It isn’t possible to specify a percentage of a certain asset or write a monetary amount.
While most solicitors and courts will be aware of this, not all of them will be. Pension providers, however, are likely to pick this up and may be unwilling to implement the PSO if it isn’t expressed correctly.
Doing the preparation work
Here we’re at the planning stage before the couple have gone to court. If you’re advising the member in their post-PSO planning, the exact value of the transfer to the former spouse or civil partner won’t be known until further down the line – see later section – but hopefully you will still have a rough idea of how much will be leaving the scheme.
Where a client will benefit from expert input here is assessing the investments to see if there are going to be any liquidity issues and helping them come up with a disinvestment strategy. The best example here is a SIPP holding a commercial property. I’m still surprised to see cases cross my desk where the scheme is mostly tied up in property and there’s no plan for raising cash. In cases where the property is the main asset, it’s strongly worth asking the client (or their solicitors) if a PSO is appropriate.
If you’re advising the party who will receive the transfer (also known as a ‘pension credit’), there is a different challenge, specifically trying to ascertain how much they’re likely to receive. There are regulations that specify what information a pension provider can give and to whom. Unfortunately, they don’t require the provider to give a valuation of the scheme to the spouse/civil partner. Again, note that the exact value won’t be confirmed until later, but if this is information that you need the best approach might be to see if the member is willing to provide it voluntarily.
It’s also worth considering the impact on lifetime allowance protection. For the member, they can potentially lose primary protection or individual protection if their total pension funds drop below a certain level. If they have enhanced protection or fixed protection, any contributions will revoke the protection. However, they might want to rebuild their pension after the PSO, so may choose to revoke.
If the person receiving the credit has enhanced protection or fixed protection, the pension credit will have to be transferred into an existing pension scheme, otherwise they will lose the protection. If the member’s pension was in payment, and it came into payment after 5 April 2006, the spouse/civil partner will be able to apply for a lifetime allowance enhancement factor. They might not need it, but there is no harm in applying for it. They have five years to do so. The member, however, doesn’t get any of their lifetime allowance back.
Court order comes into effect
Once the couple have been to court, settled their affairs and been granted a divorce, the next milestone in the pension sharing process is the “Transfer Day”.
This is later of two dates – the date of the final order for divorce (previously known as a decree absolute) and 28 days after court order was granted – and it’s important as it’s the day that the PSO legally comes into effect.
Be careful about what transactions take place before and after this point. Contributions before this point will be included in the shareable fund value: contributions after it won’t. Providers may be cautious about allowing large withdrawals after that point, but they should hopefully still allow ongoing income withdrawals to continue. These ought to be factored back into the fund value for calculation purposes so the spouse/civil partner isn’t disadvantaged.
Note as well that if either party dies, the order must still be implemented, albeit if the person due the pension credit dies, the pension scheme will distribute death benefits to their beneficiaries rather than make a transfer.
Sending the documents to the pension scheme
The couple will typically receive the court documents two-to-four weeks after the date of the court hearing. The pension scheme will need to see copies of the court order (including annex) and the final order of divorce. They’re also likely to need some kind of transfer paperwork indicating where the ex-spouse/civil partner is transferring the pension credit to.
The process can’t start until they have these documents, so encourage your clients to send them to the scheme administrator as soon as possible. The divorce process can take a while, and clients will have expectations around what amount is expected to leave their pension. The longer the process takes, the more likely it is that the final amount will be different to initial expectations.
If you’re advising the credit recipient, it will take time to assess options and make a recommendation. However, if the provider considers they are taking an unreasonable amount of time, the scheme may settle the order internally (provided the scheme rules permit it).
Once the scheme administrator has the court documents and any transfer paperwork, they can begin the implementation period. This is a four-month period within which the pension credit must be transferred.
To calculate the value of the pension credit, the scheme administrator must obtain a new valuation of the pension scheme. It can choose any day within the implementation period to be the “Valuation Day”. However, scheme administrators will likely have a company stance so as not to be seen to be cherry-picking a date that will suit their customer or disadvantage the ex-spouse/civil partner.
They will then apply the percentage in the annex to the valuation as at the Valuation Day. The value of the pension credit is then set in stone, and the scheme must give effect to a transfer of that amount.
The point to make here is that the valuation on the Valuation Day will almost certainly be different to the valuation at the beginning of the process, which could be six-to-twelve months earlier. Clients will often have a monetary amount in their head of what they believe they agreed to transfer. A PSO, however, works on a percentage basis, so will often produce a different amount, particularly so the more time has elapsed.
In theory, a percentage should be fair to both parties. Perceptions might differ, however, if other marital assets – property in particular – have remained at broadly the same value over that period. In my opinion, this is a flaw in the system, and if you look up ‘moving target syndrome’ online you will find plenty of analysis on this issue. (It’s interesting to note that pension sharing in Scotland, by comparison, can be based on a monetary amount.)
Making the transfer
The next stage is to make the transfer. Hopefully, adviser and client have planned how they can make cash available for the transfer, and they may even have sold some investments already.
Pension providers will be aware that the Pensions Ombudsman expects them to settle PSOs as soon as is reasonably practical, and complaints have been upheld even where PSOs were settled within the four-month period. Therefore, do not leave it too late to make cash available, as the provider might get itchy feet and may potentially dispose of assets themselves.
Occasionally clients will enquire whether it’s possible to settle a PSO in specie (i.e. by transferring investments). The pension sharing legislation was written over twenty years so it’s silent on the issue, and it may come down to whether the scheme administrator is comfortable allowing it.
On one hand, it can be perceived as easier to process, particularly if the adviser is advising both parties and the funds are staying on the same platform. On the other hand, the provider might be cautious about saddling a potentially vulnerable customer with investments that aren’t appropriate for their retirement needs. There might also be practical challenges given the value of the pension credit is fixed but the value of the investments is fluctuating, so it might be difficult for a provider to evidence that they’ve transferred the requirement amount.
Wrapping up loose ends
At this stage, the pension credit has been transferred, and the couple have achieved their ‘clean break’. They can both now get on with their retirement planning. A PSO can’t be varied once it’s been granted, nor can a second PSO be granted on the same pension scheme for the same divorce, so everything now is final.
If the member’s pension is in capped drawdown, the scheme administrator will recalculate a new maximum income. This will come into effect at the start of the next income year. For the ex-spouse/civil partner, they will receive the funds as uncrystallised. If the member’s pension was in payment, there will be no tax-free cash entitlement on the funds, but on the flip side taking income will not trigger the money purchase annual allowance.
This article was previously published by FT Adviser
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