Why unwinding pensions can be a complex affair after divorce: Sarah Coles

The accepted wisdom is that nobody has any staying power anymore. But I’d beg to differ, because we’re showing more long-term commitment to marriage than ever before: we’re staying married for an average of 13 years before getting divorced, which is the longest since records began in 1963, according to data from the ONS. Unfortunately, this comes with financial complications.

Divorce rates have been around 8.4 per thousand for the past decade, dropping gradually from a peak of 14.2 per thousand in 1993. The lower rate owes much to the fact that people are getting married later and cohabiting for longer before tying the knot, so have plenty of time to consider their compatibility – rather than just a commitment to sticking it out.

Because divorce comes further down the track, there’s more chance that the couple have built assets together, and planned for the future on the assumption they would be retiring together. It means unwinding their finances is more complex, especially when it comes to the pension.

In many cases, one of them will hold the majority of pension assets, often the man in heterosexual relationships. New research from the Pensions Policy Institute (PPI) shows women aged 55 to 59 have around half (54%) the pension wealth of men of the same age on average. Anyone going through a divorce needs to consider their pension carefully, but for those married for longer and divorcing later, it’s particularly essential because there’s less time to rebuild.

There’s a risk the pension is overlooked. Research has shown that 60% of women going through a split don’t discuss pensions during divorce, in some cases because they don’t know they can share a pension and in others because they don’t have any idea of the value tied up in it. After any family home, it’s often the most valuable asset held by the couple, so it’s essential that it’s included in any settlement. Pensions are also often held entirely in one person’s name, so if they’re overlooked, the other person can miss out entirely.

In a short marriage between younger people, the general approach will be to only share the portion of the pension built up during the marriage – sometimes referred to as the ‘matrimonial share’. In a longer marriage, the starting position would be a 50/50 split of the pension. There are broadly three ways pensions are treated on divorce: offsetting, pension sharing orders and pension attachment orders.

Whatever option you take, the first step will be to value the pension. The valuation most people are familiar with is a cash equivalent transfer value, which your pension providers will give you without a charge. This can be a reasonable assessment of the size of a defined contribution pension pot. However, it is usually a huge underestimation of the value of a defined benefit pension, especially when payouts are index-linked. It’s why it usually makes sense to get a specialist actuarial valuation.

Armed with an understanding of the value of the pot, one common approach is offsetting, where the couple trade off various assets against one another. It might mean one of them will take the pension and the other will have the equity in the family home. It appeals to couples because it feels relatively uncomplicated, and it means you can have a clean break.

However, you need to understand exactly what you’re giving up. If you don’t have a pension of your own, and hang on to the family home at the expense of sharing your partner’s pension, you will have to rebuild from scratch. Depending on your age, it can mean you retire with all the expenses of running and maintaining a property, with far too little income to cover the cost. It’s why anyone who uses this approach needs to focus on their pension as early as possible after the split.

Another popular option is a pension sharing order, where the total value of all pensions is calculated, and then the pensions are split between you. This is a clean break, and has the advantage that nobody has to start again from zero. However, it can be complicated and requires a court order, which can put people off.

How the pension is divided will depend on the type of pension and your age. For older people with a number of different pensions – including defined benefit ones – the focus may be on finding a way to give you an equal income in retirement. For simpler arrangements, where all the pensions are defined contribution, they may be divided by a percentage of the pots.

The third option is far less common and is known as a pension attachment order or earmarking. The pension continues to be held by one member of the couple, but the income payments in retirement are split. It means nobody needs to start all over again with pension saving, but the downsides of the approach make it less common. It needs a court order and it isn’t a clean break. The income is all taxed as belonging to the person holding the pension, and they can control when they take their pension, so they can delay when their ex-partner gets an income.

It’s not always straightforward, and can be expensive, but getting a fair division of pensions is essential to avoid anyone having to rebuild more than they need to, while trying to get their life back on track.

You might think that this is something you don’t really have to worry about, especially if you have been happily married for decades. However, the official statistics demonstrate that no marriage is guaranteed to last. Among couples who married in 2015, 16% had divorced before reaching their 10th wedding anniversary, while 35% of those married in 2005 had divorced by their 20th anniversary. It means one in three of these marriages are ending in divorce, so you don’t have to be particularly unlucky to find yourself in the divorce courts.

Lump sum risks

The tax-free lump sum is everyone’s favourite part of the pension, and the vast majority of people take this money. However, new AJ Bell research among a cross section of people over the age of 55 has revealed three potential problems.

Overall, 26% of people said they took the first payment from their pension while they were still working. This will include some people who are phasing retirement, and continuing to do some work to supplement their pension income. However, when we narrowed it down to people who weren’t doing any work in retirement, 23% had drawn money from their pension before they stopped work. It raises the risk they are using it on nice-to-haves while they’re working, rather than thinking of it as part of their retirement income.

They’re taking it early too, because 76% of people aged 55-64 say they have already taken the lump sum from their pension. Taking the cash early comes with two downsides – it restricts the total they can take tax-free, and it hampers the future growth of their pot.

There are issues around how it’s spent as well. Of those who say they have taken a lump sum, only 30% used the first pension payment to cover living costs. Meanwhile, 26% paid for home improvements, 21% spent it on a holiday, 19% paid off debt and 16% bought a new car.

This isn’t a fundamentally bad idea if they have factored this into their plans from the outset. However, there’s a real risk many of them haven’t considered the implications - and considered what they stand to lose from their pension income if they spend the cash on something else.