How do you divide pensions fairly in the event of a divorce?

Pensions are often neglected in divorce settlements, despite their value to both partners as community property in a marriage.

What happens to the shared home is usually a priority, for immediate practical reasons, especially if a couple has children.

No-fault divorce legislation introduced in spring 2022 has made separating easier and faster, but critics say the new emphasis on haste means it could leave many ex-spouses worse off.

How do new DIY divorces work?

Couples can now divorce within six months of first filing, even if one partner opposes it, and the process is largely online – including filing divorce papers by email.

But financial settlements relating to assets, including pensions, are still handled in a separate and parallel process, which can continue after the divorce becomes final.

“Pensions are increasingly an important issue in divorce cases, but for the growing number of older couples getting divorced, private pensions are often the most valuable asset after the family home,” says lawyer Francesca Davey of law firm Nockolds.

However, she warns: 'As more and more people arrange a do-it-yourself divorce online, the chance of making mistakes when it comes to pensions is increasing.

'Couples divorcing may place too much emphasis on the home and overlook the other spouse's pension pot.

'For someone with little or no pension provision, this can be financially disastrous. If a spouse has built up even a modest final salary pension plan, there is a good chance it will be worth significantly more than the average British home.”

Experts say there are three main options when dealing with pensions in a divorce: sharing them on a 'clean break' basis, where one partner sets aside a portion of the income to be paid to an ex-spouse after retirement, and its value is offset by other assets.

Below we look at the pros and cons of each and discuss some more tips on what to do and how to avoid the worst pitfalls when dividing pensions.

1. Pension sharing

In the event of divorce, the pension is immediately split into two separate pots. Each ex-spouse walks away with a share, which they manage themselves from that moment on.

This allows for a clean break and ensures neither is left in the worst possible position when it comes to building a retirement income, says Sarah Coles, head of human resources at financial services firm Hargreaves Lansdown.

But she says the downsides are that it can be relatively complicated, and requires a pension sharing order from the court, which will determine how the pension should be shared.

'It may be useful to seek financial advice to increase your chances of a fair distribution. You may also need more advice if the pension needs to be transferred and when rebuilding your pension savings. This will come at a cost,” Coles said.

'It gives both partners work to rebuild their pension.'

Francesca Davey, principal associate at Nockolds, says: 'The advantage of a pension sharing order is that the fund is divided immediately between spouses, meaning the applicant knows what is going into his or her pension pot now and can plan ahead.

'People should think carefully about whether a pension attachment or a pension participation is the most suitable remedy.'

2. Pension attachment or earmarking

A percentage of a person's future pension income and the fixed pension amount is paid to the ex-spouse when he or her retires.

Coles says this allows the pension to be shared so no one has to start from scratch, but it has to be ordered by the court, which comes at a cost.

'It's not a clean break because it's essentially alimony paid out of the pension. All tax is paid by the person receiving the pension, even if some of the income is received by the ex,” she says.

“The person who doesn't have the pension has no control over when they receive the benefit. His ex can therefore postpone the benefit.

'They can also stop paying off that pension and build up savings elsewhere. And when they die, pension benefits to their ex stop.”

Davey warns: 'In many cases, a pension garnishment is not the most suitable solution. The reason for this is that the order does not prevent someone from transferring money from their pension, nor does it require them to continue making payments. Therefore, unless the pension is already about to be withdrawn, it may be ineffective.

'A seizure is risky unless the pension is already about to be withdrawn. It is important to look at the precise benefits of the pension type to avoid missing out by choosing the wrong option.'

3. Pension compensation

A pension is retained by the holder and its value is set against that of other joint assets.

“It's a relatively simple way to achieve a clean break,” says Coles. 'It can ensure that one half of the couple can continue to live in the parental home.'

But she adds: 'Anyone who gives up their right to a pension will have a mountain to climb when it comes to building up a decent income for their pension.'

What else should you take into account? Regional differences

“What can be divided depends on where in Britain you get divorced,” says Menna Cule, head of the Birmingham office at asset manager RBC Brewin Dolphin.

'In England, Wales and Northern Ireland, the total value of the pensions you have each accrued, excluding the state pension, is taken into account.

'In Scotland, only the value of the pensions that you have both accrued during your marriage or registered partnership is taken into account. Normally, anything you accrued before you got married or after your 'divorce date' doesn't count.'

Do you need financial advice?

Not understanding the value of what you have is a pitfall for people going through a breakup, says Coles.

'A divorce process involves dividing your assets, so you need to understand their value. Couples often offset assets, but it's important to appreciate the value of what you're giving up and talk to a financial advisor if necessary.

'There are a few options to consider, so you need to be sure you choose the best one for your circumstances.'

Ben Glassman, partner and head of family and divorce at asset manager Evelyn Partners, says it is important to seek both financial and legal advice from the start, and not wait until a divorce settlement has been agreed.

'The divorce process can be confrontational, but also nuanced. There are many opportunities for conflict, distrust and misunderstandings and that is why it is important to have the right team supporting each party.

'Independent financial assessments can both benefit the divorcing parties and provide clarity about the true value of the couple's marital property.

'Involving a financial planner at an early stage means that they can help shape the divorce settlement, so that an optimal result is achieved in the long term.

'In particular, the gut reaction is often to hold on to the family home, but this may not always make financial sense, especially if there are other sizeable assets to consider, such as pensions.'

Have you thought about taxes yet?

Couples who split their assets and have separate incomes after a divorce should consider the tax implications and whether they need help from an accountant, financial advisor or planner.

This is especially the case when it comes to a large pension. Inheritance tax, income tax and capital gains tax can also be affected by a divorce.

> How do you find a good accountant? This is Money's tax expert, it explains

Don't forget your state pension

These are also important, especially for women who often have gaps in their careers that could affect their state pension rights, says Glassman.

“It's important to get a projection, especially if we want to equalize the pension rights of the two spouses.”

You can have one forecast of the state pension here and check your National Insurance record for any gaps here.

Update your wishes form with your pension scheme

Keep your wish forms up to date and keep your pension schemes up to date, says Helen Morrissey, head of pension analysis at Hargreaves Lansdown.

'At the start of your pension, you completed a wish statement in which you indicated to whom you would like to receive your death benefit.

'However, this may have been a long time ago and you have divorced, separated or started a new relationship in the meantime, so the person named on the forms may not be the person you want to benefit from achieve.

'Although in some cases administrators/trustees have the discretion to award death benefits to someone other than those listed on the form, sometimes they do not. It is best to ensure these are updated regularly so that your wishes are taken into account in the worst case scenario.'

Are you still married and hope you never divorce?

Couples who make decisions about retirement savings together have a greater chance of a richer retirement.

Financial experts say a joint approach to pensions will leave couples better off in retirement. However, there are some potential tax pitfalls, and there are circumstances where it makes financial sense to focus on retirement for higher earners.

> How couples who save together can maximize their retirement: Read eight tips from experts