For many people facing divorce, the value of their pension fund may be their biggest asset. The most common way to factor the value of that fund into a divorce financial settlement is for the value of another asset held, such as cash or property, to be offset against the value of the pension fund.
However, It is common practice for the value of the pension fund to be reduced, but why and by how much?
Why the Value of a Pension fund is Reduced when Offsetting
An existing pension has already enjoyed tax relief on the contributions made into it. This means for example, that if Spouse A had a £10,000 pension and Spouse B had £6,000 in cash and was a higher rate (40%) tax payer, the £6,000 could be turned into a £10,000 pension fund through tax relief on the contribution. That would then equalise the value of the pension funds.
In addition, Spouse B with £6,000 in cash has the choice to use that money today whereas Spouse A must wait until retirement age before he has use of it and even then only 25% of the fund can be paid as a lump sum with the rest as an income for life; where the payment term is uncertain and where there is often no value on death.
One of the leading court cases on pension offsetting is Maskell v Maskell where Lord Justice Thorpe established that the value of pensions and the value of other liquid assets should not be compared on a like-for-like basis. The Judge directed Maskell and Maskell back to mediation to sort out the right value for offsetting rather than provide guidelines. As a result, it is not uncommon in a contested divorce for the lawyer acting on behalf of the spouse with the pension to argue, incorrectly in my opinion, that no value should be apportioned to pensions.
The Reduction Factor
In terms of how much should be offset, it seems that in practice values apportioned have ranged between 25% and 80% of the pension. So if one spouse holds £100,000 more in a pension fund than the other, the range of potential cash offset could be between £25,000 and £80,000. That’s quite some spread and not particularly helpful for divorcing couples.
Solutions to Potential Arguments over the Value of Pensions when Offsetting
This leads me to two points.
First, I was pleased to see that Bradshaw Dixon Moore, a firm specialising in actuarial reports for divorcing couples, announced on 30th September 2009 that they now have a Pension Offset Report service available. The report factors in both the tax issues and the importance of cash. They use actuarial principles and utility theory in reaching an adjusted value for the pension and the report can be used in Court. It costs £200 + VAT and for any party who feels very concerned about how the value of pension funds have been offset, this could be a useful solution.
Secondly, the variation in offsetting values highlights that there is great potential for a raging argument over how to fairly separate assets on divorce. If you are at the stage of wondering what type of divorce may suit you best, it is worth noting that one of the key attractions of a collaborative divorce is that both parties can work with a highly qualified and experienced Financial Neutral to work out how to split assets fairly and make a joint and informed decision on what value to apportion to pensions. A Financial Neutral can also help you decide whether pension offsetting is the best option, explaining the relative advantages and disadvantages of pension sharing for your circumstances.