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  Introduction   Money purchase scheme
  Final salary scheme   

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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.

Deferred pension at the time of divorce:
(15/60 x £40,000)
Cash equivalent transfer value calculated by the scheme actuary for pension sharing:   £100,000
Pension debit ordered by the court:
(40% of the CETV)

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:   £80,000
The members full pension entitlement:
(30/60 x £80,000)

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.
The members actual pension will be:
(£40,000 - £7,400)

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.
The members actual pension will be:
(6/60 x £80,000)
The members actual pension will be:
(£40,000 x £8,000)

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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