Pensions in Ancillary Relief

A very useful article on pensions in divorce written by Tom Tyler from the four brick court website.

PENSIONS IN ANCILLARY RELIEF CASES

 

Pensions in Ancillary Relief Cases

The Welfare Reform and Pensions Act 1999 brought in the concept of pension sharing for divorcing couples. The ethos behind the change in the law was two fold. The government wanted to do its best to ensure that divorcing wives had pensions of their own in order to try and save the state from having to provide for them. Also there was the perceived unfairness that wives who had been out of the labour market due to child care responsibilities would not have built up pensions comparable to their husbands.

This line of thinking was consistent with the reasoning of White v White [2000] 2FLR 981 where fairness and equal sharing of the family assets in a non discriminatory way was given such prominence for the first time. The Pensions on Divorce etc (Provision of Information) Regulations 2000) stated that the Cash Equivalent Transfer Value, (CETV) was to be used to value the pension assets in every case.

Up and down the land District Judges would lump this CETV in with all the other assets and divide them up in whatever proportions seemed right. It was easy, simple and seemingly unarguable. That was until the case of Maskell v Maskell [2001] EWCA Civ 858 where the Court of Appeal for the first time pointed out that it was not as simple is that.

In Maskell the Court highlighted that a pension was simply a future income stream and not a capital asset. There were big differences between these assets. A matrimonial home could be sold for cash or passed to another person upon the death of the owner. A pension can not be sold and will be extinguished on the death of the owner. The Court of Appeal pointed out the perils of trying to compare apples with pears.

Some District Judges took Maskell to heart and others did not. It all depended on which court you were in. However, there has been a growing awareness that you do not simply add up the CETV in one column and then offset them against the hard assets in the other column.

I am sometimes shocked at how pensions are approached in ancillary relief cases because I see a class of asset which is complicated being treated in a very simplistic fashion.

I am sure that the results achieved in very many cases often do not correspond with what is intended by some advisors.  What is worse for the client's is that the errors made by their advisors might not come to light for many years to come.

Dealing with Pensions on divorce is one of the biggest financial transactions that a person can make in a lifetime. In advising on pensions I have found myself asked to give what is tantamount to financial advice and in the absence of expert evidence I worry about this. I believe that dealing with pensions without specialist knowledge is a rich source of potential professional negligence traps for the unwary.

Giving such advice is one of the few remaining areas that is unregulated and for the time being an area not covered by the Financial Services Act.  How long this state of affairs is allowed to continue remains to be seen. However my advice is to tread very carefully indeed when dealing with pensions and to routinely seek expert advice in anything other than the simplest case. 

The first purpose of this seminar then is to persuade you to take care. All of us who work in this jurisdiction must surely know by now that pensions are as different from hard assets as a apples are to pears. Less of us are aware that even between themselves pensions are very often different and distinct from each other. There are different species of pension and it is dangerous to compare them on a like for like basis.

The second purpose of this course is to offer some guidance on how to treat these unpredictable assets. There is more to dealing with pensions than adding up the CETV's on the back of an envelope and dividing them by two.

The 3 stages to consider when dealing with pensions on divorce.

• Obtain the information
• Understand the information
• Decide what to do

 

(1)                 OBTAINING THE INFORMATION:

Find out about the parties employment history

• Many people approaching middle age will have had several jobs all of which may have had some pension provision. You cannot assume that the previous pensions have all somehow been passed on down the line and somehow rolled up into the pension scheme of the present employer. Preserved pensions from previous employments can have a surprisingly high value. Therefore, ensure Form P is sent to all previous employers. More about the Form P later on.
  
  

• Find out about the extent of pre marital contributions. There may have been considerable pre marital contribution to the scheme which may have an effect on the outcome of the case. This sort of contribution could in an appropriate case lead the court to depart from equality in the same way as a party who brings a large capital contribution into the marriage by way of the proceeds of sale of a previous home or an inheritance.
  
  
• Pay attention to periods of self employment
  
  
• Find out about any significant post separation pension contributions. These too may effect the ultimate outcome

 

Pay particular attention to state pension provision.

• The state pension is has two components (a) BSP basic state pension, (b) ASP additional state pension that encompasses the old SERPS and SP2 pension. (*) SERPS is an acronym for the old State Earnings Related Pension. This was a form of contributory state pension that existed from 1978 to 2002 when it was replaced by SP2. It became very popular to opt out of SERPS in the 1980's and invest ones contributions in a personal pension. There were many examples of policies being mis-sold to employess who were often advised that they would be better off than staying with the state scheme. This was sometimes bad advice. However, many employess did opt out and remain opted out of SERPS/SP2.
  
  

• SERPS/SP2 only applies to employed people. A self employed person will not have any SP2/SERPS entitlement. The self employed are expected to make their own provision and are permanently ‘opted' out so to speak. Therefore always investigate periods of self employment because during those periods the party concerned may well have contributed to a ‘money purchase/stakeholder' scheme of his/her own volition
  
  

• Do not underestimate SP2. It is particularly relevant to those who earn £30,000 p/a or less. It is quite possible for a wife who has had various low paid jobs thorough the marriage to have built up a SP2 entitlement that is greater than her husband who opted out of SERPS SP2 and bought a stakeholder pension or other money purchase scheme. Potentially an employee with maximum SP2 entitlement may have a pension with £125,000 CETV value.
  
  
• CETV lump sum of ASP available by filling in From BR20 from www.thepensionservice.gov.uk
  
  

• Pension sharing of ASP available
  
  
• No costs for sharing ASP
  
  
• Consider availability of pensions credit and savings credit for older clients

 

Ensure that Part 2.13 of the Form E and Form P is filled in properly.

• A properly completed Form E and form P ought to provide all the information that is needed and do away with the need for questionnaires in pension cases. Whether the family lawyer is qualified to understand and act upon the information provided is another matter entirely.
  
  
• Form P asks for the date CETV is calculated. This is a new requirement and essential given that the CETV may lawfully be calculated as long ago as 1 year prior to the petition.
  
  
• For example Part B question 2 in the form enquire as to how the CETV was calculated
  
  
• For example Part B question 3 asks what benefits are included in the CETV
  
  
• For example Part C question 3 addresses under funding. This is a big problem area these days with around 75% of private sector pension schemes being under funded. (2)

 

(2)                 UNDERSTANDING THE INFORMATION

CETV values

The CETV is the Cash Equivalent Transfer Value. This is a money value that the pension provider will provide upon request from the scheme member. The original purpose of the CETV was to value the bundle of assorted component pension benefits for a scheme member who wanted to transfer his pension to an alternative pension provider. It was never originally intended to value a members pension for divorce purposes. It was pressed into service as a valuation tool for divorcing scheme members because it was cheap and readily available. 

The problems in relying on the plain CETV are two fold. The first problem is that the value of the benefits are taken as if the members was leaving the scheme at the time that the CETV is calculated. This is clearly unrealistic in the vast majority of cases. Secondly, there is no uniformity among pension providers in how a CETV is calculated. Pension scheme actuaries have a discretion as to which benefits are included and excluded. For example valuable benefits such as widows pension and generous early retirement provisions do not have to be included in the CETV, but they might be. This inconsistency makes the business of valuation rather unpredictable.

The effect of this lack of uniformity of approach means that the ultimate CETV value of the pension can be entirely misleading. It may help to compare it to valuation of the former matrimonial home where the valuer has not included the kitchen in the valuation. No client would be happy with a valuation like that. However when it comes to pensions, such inconsistencies are overlooked because of plain ignorance on the part of both client's and their advisors of the assumptions and errors that have gone into its production. The writer has had an actuary tell him that far less care goes into the production of a CETV to be used for divorce purposes than if an actual transfer out of the scheme was contemplated. It will be recalled that this is the original purpose of CETV.

 

Set out below are some of the drawbacks of relying on CETV value alone in 3 different kinds of pension schemes.

C. E.T.V. for final salary or defined benefit schemes (see note²)

• CETV values the pension as if the member left the scheme at the time of valuation. It is a highly artificial figure particularly in the case of final salary or defined benefit schemes: Some potential problems
  
  
• Trustees can direct the scheme actuary not to include discretionary benefits such as generous early retirement provision. This would make the value seem artificially small
  
  
• Death in service benefits are undervalued because the value of such benefits to an early leaver are negligible compared to those of an employee who stays on
  
  
• The effects of taxation are ignored in cases of employees who are close to retirement. This would have the effect of overstating the value of benefits to such employees.
  
  
• If a member is in poor health the value of the pension is overstated
  
  
• Watch out for NHS pensions, which as a matter of policy do not include widows' benefits. They are calculated on the basis of the member's prospective status as a single person. Therefore the CETV will be on the low side.
  
  
• If there is a younger member of a scheme who is expected to remain in the scheme until retirement age then the CETV will significantly undervalue the scheme
  
  
• If a young member stays in the scheme and has good prospects and can look forward to good salary increases then the CETV will be significantly undervalue the scheme
  

C. E.T.V. for money purchase schemes (see note ³)

• CETV of money purchase scheme is a statement of the value of the members account, however the CETV value given is for the surrender value of the scheme which must be unrealistic given that the scheme is not going to be surrendered, nor can it be. However the stated CETV of this type of scheme is not usually controversial.

C. E.T.V. in unfunded statutory schemes (see note ⁴)

• In general, you need to be very cautious with pension schemes for public sector employees. They are unfunded in that the employer does not set aside assets in advance of the pensions being paid. Be careful with divorces involving the following occupations.
  
  
• Police
  
  
• Teachers
  
  
• Civil servants (4)
  
  
• NHS employees (6)
  
  
• Army (7)
  
  
• Always consider obtaining expert evidence in these sorts of cases especially if the pension scheme member is approaching retirement.
  
  
• Some very surprising valuation evidence can be turned up in cases involving members of the uniformed services. In the case of police officers with long service the CETV balloons in the last few years of service leading to a horrendous professional negligence trap for the unwary
  
  
• In armed forces pensions, the calculation of the widow's pension is based on the value of the pension to a second wife not the existing wife. This is anomalous and leads to an undervalue of the CETV. This point can potentially be negotiated with the scheme to give an enhanced CETV.

Contributions

• Consider whether there are any premarital contributions to the pension fund.

For example in a 10-year marriage one of the one of the parties may have been contributing to their pension for 10 years prior to that. Often District judges will take a straight-line approach in discounting the value of the pension. This may well be actuarially flawed because it assumes there has been an equal contribution over the years, which may well not be true. In such an instance, the extra contribution pre marriage may provide an argument for departing from equality.

• Likewise substantial post separation contributions could lead you conclude that there should be a departure from equality on these grounds. The reason would be that there might be no reason why a spouse should share in assets created by the sole efforts of the other spouse post separation. See Rossi v Rossi v Rossi [2006] 2FLR 192

 

(3)     DECIDING WHAT TO DO

Has the pension been valued appropriately ?

• In every case where the pensions are a significant feature consideration must be given to whether the pensions have been valued fairly. This is difficult for the family lawyer to do unaided by an expert. It is very worthwhile to cultivate a competent Independent Financial Advisor or Actuary who is able to give you a quick low cost opinion on the pension schemes that you encounter in practice. The cultivation of such a relationship is mutually beneficial because the lawyer gets the benefit of some quick expert advice whereas the expert may well pick up some business in the form being jointly instructed should matters become contentious.
  
  
• Ask your actuary whether the CETV is fair. These figures can be negotiable. Consider taking some informal advice from a pension's specialist and see if the CETV can be negotiated with the other side on the basis that the member remained in service as opposed to leaving the scheme. You could use the mid way figure between the 2 extremes as your negotiating point.
  
  
• Sometimes substantial variations can be achieved from the quoted CETV. If you can achieved this then the chosen percentage of the recalculated CETV should be expressed as a percentage of the original CETV

Offsetting or sharing

In the days before pension sharing pensions were offset against hard assets. Typically the husband would keep his pension in return for losing much of his share in the matrimonial home. The wife would downsize later and hopefully all would be well. A lot of this goes on today of course and a pretty rough ready business it is.

White v White brought in notions of equality and this has been emphasised through the decisions in McFarlane v Mcfarlane and Miller v Miller [2006] UKHL 24. We are now engaged in a search for the fairest way to share the matrimonial acquest. Now after the House of Lords decision in Charman v Charman 2007] EWCA Civ 503 the state of the law is that equality is in there at the beginning of the decision making process not just as a yardstick by which the result is to be judged.

Fairness can mean that the hard assets and the contingent assets are to be shared equally. This makes offsetting harder to achieve and it is becoming rarer which may be a bad thing in some respects because offsetting still provides a simple solution in many cases

However, there is no proper guidance from the courts in how much pension to offset against hard assets. Until the courts are brave enough to provide some guidance on this, then the whole process will be somewhat mysterious. My feeling is that much of the advice given by lawyers in this area amounts to no more than guesswork in the absence of expert advice

Offsetting

What types of case point to an offsetting solution ?

• A short marriage will usually point toward offsetting rather than pension sharing
  
  
• A young couple will usually be best advised to go for offsetting
  
  
• Pensions with a low value can usually be ignored of offset
  
  
• Cases with a foreign pension scheme point to offsetting because of the difficulties of a foreign scheme being subject to the jurisdiction of English courts

In considering how much loss of pension to offset against capital the following factors need to be born in mind

• The cash sum arrived at will be free of tax. This is in contrast to pension income which in terms of income paid to the pensioner is usually expressed as gross income. 
  
  
• The cash sum is immediately acquired rather than it's receipt being postponed until a later date as is the case with pension income
  
  
• The pension scheme member might die and therefore he will never get the pension income. This is in contrast to the recipient of cash.
  
  
• If you do opt for offsetting in the writers view there is a lot to be said for seeking actuarial advice on how much should be offset to achieve a fair outcome. Actuaries can usually advise on offsetting if they are asked to do so and in the absence of any approved way of going about this task, it is suggested that it must be the safest course of conduct for all concerned.
  
  
• It is suggested that a sensible approach might be to ask the expert to give a view on how much capital would be needed to replace the pension benefits that are being foregone by the party who takes cash in place of pension share. The expert would take into account the generous tax relief attracted by pension contributions and would be able to give an accurate assessment of the cost of replacing the benefits

 

Pension sharing

Pension sharing will be the usual route to go down in long marriage cases where the pensions are a significant part of the overall assets. In some cases where the pensions are of a similar type, say money purchase or stakeholder schemes of low value then giving the parties parity of CETV may well be right. In cases where the parties are a long way from retirement then dividing the pensions in this way provides a practical and sensible answer

• It is vital that you find out the practical effect of sharing a pension. The internal rules of the scheme can provide for some surprising results should a pension sharing order be made. For example I was told of one case by a colleague where the unshared pension was set to provide £30,000 p/a to the scheme member upon retirement at age 60. An actuary was instructed to report on how parity of retirement income might be reached. Surprisingly, on the operation of a pension sharing order the income to both parties only amounted to £8,000 p/a each upon retirement at 60. The reason for this was because the internal rules of the scheme provided that upon a pension sharing order there would be a loss of the members advantageous guaranteed annuity. Needless to say this surprising fact would have remained undiscovered by the parties until retirement had the actuary not been instructed.
  
  
• Be careful of local government pension schemes. Local governments like other employers are conscious of the high cost of providing generous pensions to employees who live longer. Therefore they look for ways of reducing their liabilities to pensioners where they can. In conversation recently with an actuary the writer was informed that many local authorities are taking on new employees with far less generous pension arrangements than longer serving employees. There is no surprise about that but what may come as a surprise is that although the retirement benefits of the long term employee will remain advantageous in comparison with new arrivals, the effect of a pension share on these better rewarded employees will be that the shared pension benefits gained by the transferee spouse will be based on that which is paid to new arrivals, i.e. at an inferior level of income.  A close examination of the scheme rules by an expert would discover this sort of thing. Whether an unassisted lawyer would do so is another matter. 
  
  
• In cases where there is more than one scheme, choosing correctly the scheme to share is vitally important in terms of the income that is derived. Choice of which scheme to share can have a radical effect on the outcome upon retirement because of the internal structures and rules of a particular pension scheme. Knowing which scheme to share is not in the writers view something that a lawyer is qualified to advise upon.  

In cases of longer marriages where retirement is nearer then the only basis for advising the client to do this is for the client is to know the amount of pension to be received for the given share. For the client to receive X% of the CETV does not really tell them anything. The CETV is the starting point and the finishing point because it is the CETV that will have a sharing order applied to it. Treat it as a means to an end.

• If one opts for pension sharing then very often one is aiming for an equal outcome. What amounts to an equal outcome? Is equality achieved by equalising the pension assets or by aiming at an equal pension income from assets that have been earned by both parties in the course of their marriage? It is suggested that we should concentrate on achieving an equal income stream from these assets because that is the only thing that should matter to the client. If this is to be our aim then in many cases an actuary will be required to find the appropriate method of sharing the pension assets. This is for the very simple reason that splitting CETV's down the middle will hardly ever achieve this result of equalising income in the most efficient and cost effective way. The risks in adopting this simplistic and wrong approach are considerable both for the client and for us.
  
  
• Remember to factor in the costs of sharing and who should bear the costs. If the order is silent as to costs then it is usually the transferor who will pay. If there are several pensions that could be shared then sharing them all would be expensive in terms of costs. Perhaps only one needs to be shared. Less sharing will keep costs down

CONCLUSIONS

In every case, consider the following:

• Decide if your case is going to be one for offsetting or pension sharing
  
  
• Treat CETV's with a healthy scepticism. Remember that in the right circumstances they are negotiable.
  
  
• If there is to be a sharing order then the golden rule must be to determine what the result of a pension share will be for the parties and to ensure that the client is fully aware of it. The CETV is meaningless to the client. The end result is not about share of CETV. The essential thing is to examine what pension will be received in terms of annual income.
  
  
• Always consider obtaining expert advice, even at an early stage

 

Explanatory Notes.

 

⁽¹⁾       Basic State Pension (BSP) and Additional State Pension (ASP) are the 2 components of the state pension scheme. A forecast for the likely benefits payable for both can be obtained by sending form BR19 to the Benefits Agency. Or it can be done online at www.thepensionservice.gov.uk.

SERPS is the acronym for the old State Earnings Related Pension. It was designed to maintain some link between actual earnings and state pension income for lower paid workers. It is dependent on contributions and the number of years in work. SP2 replaced SERPS in April 2002. SP2 is contributed to by around 22% of those or working age. This figure will probably be rising because those who contracted out of SERPS in the 1990's onwards are increasingly not finding the terms of contracting out to be advantageous therefore are re entering the scheme.

A lump sum CETV style quotation for SP" can be obtained by sending Form BR20 to the Benefits Agency or by submitting it online to www.thepensionservice.gov.uk.

⁽²⁾       Defined benefit schemes are only provided by employers as part of the occupational pension scheme for the employees of the company and are commonly known as final salary pensions. No funds are specifically accumulated for each individual member; however, an actuary must calculate the benefits paid to the members at retirement age and ensure that the pension scheme as a whole has enough money to pay the pension obligations now and in the future.

⁽³⁾       Money purchase schemes. For individuals the most common types are personal pensions, stakeholder pensions and retirement annuity policies. All of these pension arrangements can be divided by the court on divorce and are much easier to determine their value compared to a defined benefit scheme. This is because the cash equivalent transfer value will usually be an acceptable valuation of the transferable fund from the pension arrangement. The value of a money purchase scheme is dependent on the contributions made and the underlying investment growth so the CETV is an accurate value, less any charges, of what the pension is worth.

⁽⁴⁾       The civil service, armed forces, NHS, teachers, fire services, police and local authorities have access to a public service scheme for retirement benefits and where the scheme rules and regulations are defined by statue.

⁽⁵⁾       In the case of the principal civil service scheme, there is no direct cost to the scheme member as it is non contributory scheme.

⁽⁶⁾       This is in contrast to the NHS pension scheme where scheme members are expected to contribute 6.0% of their pension able earnings. The accrual rate for public service schemes is a 1/80th of the final salary for each year of service with a maximum pension income of 40/80ths for forty years of service, or half final salary. In addition there will be a non-optional tax free lump sum calculated as 3/80ths of final salary for each year of service with a maximum of 120/80ths for forty years service.

⁽⁷⁾       The Armed Forces Pension Scheme is a final salary, contracted out, unfunded occupational pension scheme and is an exception to other public service schemes being governed by prerogative instruments. These documents are not subject to approval, annulment or amendment by parliament, they derive their authority directly from the Queen. Unlike private sector companies, the Armed Forces Pension Scheme is designed to meet the special requirements of service life, where youth and fitness are essential elements of the occupation. This means that the scheme will provide immediate pension benefits to may of the members that leave early and full retirement benefits can be earned by the age of 55. The final value of the retirement benefits will depend on the members' years of service and rank, which will determine the members' pension able earnings.

⁽⁸⁾       Under funding, is a common factor in pension schemes these days. Where a scheme is under funded, the trustees have the power to reduce the CETV in order to protect the members who do not transfer out of the scheme. Remember that a CETV is the rolled up value of the members pension should he transfer out of the scheme today. Under funded schemes are supposed to put in place a special Schedule of contributions which is expected to ensure that the scheme will in time become fully funded on a Minimum Funding Requirement.

(8) The matters to which the court is to have regard in determining whether to give approval under subsection (7) include the matters mentioned in subsection (4)(a) to (c) 

______________________________________________

Powers of court

 Applications for order.

 

14.(1) Any person who is a trustee of land or has an interest in property subject to a trust of land may make an application to the court for an order under this section 

 (2) On an application for an order under this section the court may make any such order 

 (a) relating to the exercise by the trustees of any of their functions (including an order relieving them of any obligation to obtain the consent of, or to consult, any person in connection with the exercise of any of their functions), or

 (b) declaring the nature or extent of a person's interest in property subject to the trust,

 as the court thinks fit. 

 (3) The court may not under this section make any order as to the appointment or removal of trustees. 

Related Barrister or Author:

Tom Tyler