How divorce affects pensions: Offsetting
Please Note: Information in this blog was current at the time of publishing, but may no longer be up-to-date with current legislation. Please visit our blog for the latest pension articles.
Last week we gave an overview of how pensions are affected by divorce, and this post will provide more detail on offsetting the pension against other assets.
The Matrimonial Causes Act 1973 permitted pensions to be considered in a divorce settlement by way of offsetting. The Chartered Insurance Institute's Pensions and Retirement Planning 2012 gives the example that "if the member had a significant pension fund they would retain this and the ex-spouse would consequently receive a higher proportion of the remaining assets of the marriage."
It is a simple method, as shown below:
- The pension is considered an immediate asset
- When the assets and liabilities of each party are added up, the value of the pension is included
- In deciding the allocation of assets to each party, the pension can be offset in different ways. One method is for the ex-spouse to receive a deferred lump sum or income
This process is not always the same, though. Assets are not divided with an equal split in every divorce, so the pension could be ignored completely. If divorce follows a short marriage, or both parties have their own pensions, then they may be excluded from the calculation of assets and each person's pension fund remains as it was.
A clear benefit of offsetting for the non-member is that the subsequent death of the member does not affect the agreement, even in instances where the decision was to defer receiving the money.
Offsetting with a defined benefit (DB) scheme
As a defined benefit pension scheme promises a specific income, in order to be offset the CETV needs to be determined. The calculation varies depending on certain factors, such as age, salary and length of service.
Before a decision is made on what can be offset, certain parameters are considered:
- the loss of the member's pension and tax-free cash
- the loss of death in service benefit
- the loss of the spouse's pension - DB schemes often offer a spouse's pension if the member passes away first, but this is lost when the pension is offset
Offsetting with a defined contribution (DC) scheme
Unlike defined benefit schemes, defined contribution pensions are funded accounts, and their value can be seen. This makes it easy to determine the asset and work out a division of the fund between the two parties. The following parameters are considered:
- Loss of death in service lump sum (these are paid out if the member does not live long enough to start taking their pension)
- Loss of pension benefits
- Loss of spouse's pension, based on calculations made using mortality tables to decide a life expectancy of both parties
Offsetting remains a popular option, but subsequent legislation has given more choices. Next week's post will look at earmarking the pension in divorce.
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