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Introduction
Under
section 31 of the Welfare Reform and Pensions Act
1999 (WRPA) there are provisions for the reduction
of a members pension rights. These reductions are due to a pension
sharing order creating a pension debit that
will reduce the value of the members retirement
benefits as a result of divorce or nullity of marriage,
and in particular the method used for final salary
schemes.
The value of this
pension debit is determined by the cash equivalent
transfer value (CETV) or by a pensions
expert if, as the step-by-step
guide shows, the court requires expert
evidence to be provided during ancillary relief
proceedings, by the percentage ascertained by the court
order or as agreed by the parties through their
solicitors. If the order or agreement is in terms of a specified
amount, then the reduction will be by the percentage
the amount represents of the value of the retirement
benefits. Where the amount is greater than the
value of the retirement benefits, the members rights
will be reduced by 100%.
Money purchase scheme
Where the members pension rights are accrued through a money
purchase scheme such as a personal
pension, retirement annuity policies (RAPs) or stakeholder
pensions the pension
debit will be applied to the pension fund value, usually
being the CETV, as a once and for all percentage reduction.
The provider will implement this percentage value in the name
of the former spouse as an internal
transfer if dual membership is permitted or as an external
transfer to another pension arrangement if an internal transfer
is not allowed.
In many cases the spouse is nearing retirement and requires a pension income from either the internal or external transfer. For a money purchase scheme, the spouse can use the pension fund to buy an annuity and has the option to use an open market option to search for the highest pension annuity. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised pension annuities quote offering guaranteed rates.
There will be no further impact on the remaining members pension
rights. For example, if the effect of the pension sharing order
on the members pension benefits is to apply a pension debit
of 30.0% against the calculated value of retirement benefits,
then a value of £100,000 will have £30,000 removed
from the pension
fund leaving £70,000 to the scheme member.
Final salary pension
The calculation of a members reduced benefits for a final salary
pension is more complex than the money purchase scheme and will
involve the pension arrangement provider recording the pension
debit as a negative
deferred pension, to be applied at some time in the future
at the scheme members normal pension age (NPA) or an alternative
age if early retirement is selected.
This can be best illustrated with an example based on the member
of a final salary occupational pension scheme with 15 years
of membership at the time of divorce and pensionable
earnings of £40,000 per annum. The scheme accrual
rate is 1/60th of the final salary for each year of service.
The example assumes that the whole of the retirement benefits
will be subject to statutory revaluation. If the pension debit
contains guaranteed
minimum pension (GMP) rights then this part of the retirement
benefits will be subject to GMP revaluation.
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Deferred pension at the time of divorce:
(15/60 x £40,000) |
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£10,000 |
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| Cash equivalent transfer value calculated
by the scheme actuary for pension sharing: |
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£100,000 |
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Pension debit ordered by the court:
(40% of the CETV) |
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£40,000 |
This means that the former spouse will receive a pension credit
of £40,000 to be invested separately for her. If the existing
scheme permits dual membership then an internal transfer will
be allowed or if not, the former spouse must make an external
transfer of the pension credit to another pension arrangement.
The creation of pension debits and pension
credits is similar to that of a money purchase scheme,
however, for the scheme member at retirement the negative
deferred pension will adjust the members pension income as
follows:
| The member retires at age 65 after
30 years of service with a salary of: |
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£80,000 |
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The members full pension entitlement:
(30/60 x £80,000) |
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£40,000 |
By applying the statutory revaluation
order made against the scheme at NPA the scheme actuary will
calculate the deferred pension given up at the time of divorce
was £4,000 (this being the pension sharing order of 40%
of the scheme members deferred
pension of £10,000). At retirement age with adjustments
made for inflation, this is equivalent to a pension income of
£7,400 per annum and it is this figure that is applied
as the negative deferred pension.
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The members actual pension will be:
(£40,000 - £7,400) |
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£32,600 |
The statutory revaluation order ensures that the scheme actuary
does not calculate the pension
income based on the assumption that the member has given
up 40% of the rights to 15 years pensionable
service at the time of divorce, or 6 years worth of retirement
benefits. If this approach was applied the member at retirement
would have the full pension (based on a higher future final
salary) reduced by 6 years of his pensionable service.
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The members actual pension will be:
(6/60 x £80,000) |
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£8,000 |
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The members actual pension will be:
(£40,000 x £8,000) |
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£32,000 |
This would result in a windfall profit to the scheme at the
members expense equal to £600 per annum (actual pension
of £32,600 less final pension of £32,000) until
the death of the member. For schemes with accrual
rates that allow the member to accumulate maximum retirement
benefits at a faster rate the windfall profit will be greater.
The revaluation of a members retirement
benefits where the member has deferred rights in a final
salary pension will depend on the date of leaving service.
For example, in the case of members
leaving early the Social Security Act 1985 applies revaluation
of non GMP benefits from 1 January 1986. For an early leaver
prior to this date the accrued benefits will not have to be
revalued by the retail
price index (RPI) and so there would also be no requirement
to revalue the pension debit during an internal transfer.
Similarly any revaluation of the scheme members pension rights
will also apply to the former spouses pension debit. If the
former spouses benefits are taken as a pension income before
the normal
pension age, then any actuarial adjustment that would
apply to the scheme member for early retirement will also
apply to the former spouse.
For the scheme member the reduction in retirement
benefits of 40% as the results of the pension sharing order
will be applied for all types of benefits in that proportion.
This means that, for example, a member of a deferred contracted
out final salary pension with both GMP rights and excess of
GMP rights would have both these benefits reduced by a proportion
of 40% of the their determined value, whether this is the
CETV from the provider or a valuation to determine a suitably adjusted CETV from a pensions expert based on the circumstances and specific
needs of the parties.
It is important to remember that in
the case of the CETV the assumption is that the active member
of an occupational pension scheme leaving
service on the day the valuation is calculated. The CETV
is therefore a hypothetical calculation and this produces
a hypothetical deferred pension had the member left the scheme
at that time.
Similarly the benefits that are reduced are also the benefits
that the member would be entitled to under the hypothetical
pension at retirement and this will not include other benefits
such as death
in service benefits. It would therefore be important on
valuation to consider a fair value for the retirement benefits
to reflect the pension position of both member and former
spouse on divorce.
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