What is 50:50?

Our situation is that I have a substantial final salary pension, CETV ~£300k, based on 25 years service. I am 51, my stbx 46. I am likely to start drawing down the pension in a few years say ~ 55. I have agreed in principle to a 50:50 split. Stbx has no pension provision. It is possible she may offset equity against pension.

Is pension sharing normally a 50:50 of the CETV, or an asessed split of the CETV that should provide equal pension income for the two parties. (If the latter, what are the most likely assumptions?)

Currently the CETV is not reduced, although the fund is substantially underfunded. There is a significant risk that a reduction will be applied within the likely timeframe of the divorce. The company is publically quoted.

Pensions......aggghhhhhhhhhh headache!

Best wishes, Kalamri

Kalamari

Pensions give me a headache too!!!

As far as I am aware the CETV (or the true value of the pension) is mostly an issue when you are looking to offset against cash assets.

If the pension is to be shared the CETV is less of an issue - what matters is ensuring you get equality of income at retirement - and that is where it is probably a good idea to get an actuary to work out how the division should be done. Equality of income - especially where the is a disparity of ages and retirement dates - does not necessarily mean you get half the pot each now.

Now if you are looking at offsetting, that is a can of worms. There is a good argument for saying - especially close to retirement - that the pension is no different to cash and should be offset on a pound for pound basis. There is also a school of thought - with which I do not agree - that offsets should be done at a reduced amount of CETV - say 25%. This may be fair enough if the pension is a long way from being paid but look for Nigel@BDM's fairly recent post on the subject .. and read through a few of the other pension/CETV/offsetting threads - if your brain can stand it! Also if it is a final salary scheme then the CETV is not necessarily an appropriate way to value it.

Again this is something an actuary could look at. By way of example: I have a joint actuarial report on our pensions - his is final salary and MUCH bigger than my measly money purchase one. One figure that interested me was the amount I would have to put into my pension fund NOW to achieve the same pension as him at 60. It is close on £200k - the amount of the equity in the FMH. My plan is to offset the pension against the house. I am due for FH next week. Will report back on how that plan worked out

Hadenoughnow

Aggghhh indeed!

Pension offsetting is based on the value of the pension and the CETV is the starting point. CETVs undervalue pensions, so you must be prepared to have the £300k CETV challenged at some point.

Pension sharing (a debit against your pension and a corresponding credit to her) can be based on the capital value, where the split is just determined by the CETV, or with income objectives. Income objectives can take various forms, for example to equalise retirement incomes at a specific point. Income equalisations are typically age related, for example equalising incomes at her age 60, or 65, or some other point. The key point is that equalising incomes will almost never equate to equalisation of CETV.

As to what are the most likely assumptions (I assume that you refer to income equalisation points), the most common and logical, is the earliest point at which you can both take retirement benefits from your resulting pensions. Like most things involving the “P” word, this is not particularly straightforward. The first issue is your pension scheme’s policy on pension sharing and whether they offer internal or external credits to the recipient. All public sector schemes only offer internal credits; many private sector schemes only offer external credits. This policy will determine the earliest possible retirement age of the pension credit member. Even if your scheme offers internal credits, her retirement age could be higher than yours as she will be a deferred scheme member whereas you will be remain an active member. Many schemes have higher retirement ages for deferred members.

Underfunding – is almost as bad as the “P” word itself. The scheme does not currently hold sufficient assets to cover its actuarially calculated liabilities, and is therefore technically underfunded (the term is being phased out, but the facts are the same). The chances are that in the current economic climate, this has got worse rather than better. Pension scheme trustees have the option of adjusting (reducing) CETVs if the scheme is underfunded. Under the current regime, the scheme’s underfunding will have little relevance for you as a member. It is very likely that as the scheme is underfunded, the only pension sharing option will be an external credit – the credit will go to a private pension that the recipient must choose. If this is the case, there is a real danger that a pension sharing order will result in the value of the two resulting pensions being lower than the original pension. In other words, the pension sharing order could cause unintentional financial damage.

Some practitioners have suggested that it is theoretically possible to force a pension scheme to grant an internal credit rather than an external one if the external credit would be adjusted due to the scheme funding position. I am not aware of any precedents for this and my guess is that any landmark case will involve very substantial professional costs.

Even if the scheme does not adjust CETVs due to underfunding, the value is still unlikely to be a fair one. You can spend money obtaining an independent actuarial valuation of the pension, which may well produce a higher valuation, but that will not change the CETV. Therefore, a pension sharing order that results in an external credit is very likely to crystallise the theoretical loss and cause financial harm. That is why our actuaries insist that all the pension sharing reports we do include an analysis of how the sharing order will be implemented so that any potential for harm is identified and clearly reported on.

Peter.

Thank you for your advice. It's clearly complex.

I feel that having readily accepted 50:50 for equity and pension, I was not expecting to find that I might get less than 50:50 of CETV because the pension is shared on the basis of equal pension income. If we just had money in the bank, or direct contribution pensions, it would be split 50:50. So why is a final pension valuation treated differently?

Kalamari

I did not mean to imply that pensions are automatically treated differently, but merely to say what could happen. As to why this happens, I believe that it is a mixture of unintended consequences and inevitable confusion about whether pensions are capital assets or income streams.

My own feeling is that arguments can be made both ways and practitioners are likely to prefer the argument that is best for their particular client. As you rightly say, if the pension were a defined contribution one and therefore represented by an identifiable capital fund a 50:50 split on capital value makes some sense.

The problem is that defined benefit pensions are actually promised future income streams. It is possible to place a capital value on the pension and this is of course what is done on divorce. Treating pensions as an income stream and sharing them on that basis makes obvious sense when the pension is in payment, although even that has its challenges.

Perhaps the easiest way to look at the whole issue is to look at a series of scenarios. If a couple have between them pension promises that will provide an annual income stream of £20,000 when they retire, it could be held that they will jointly enjoy that income. Divorce means that they will no longer enjoy that income together and an equitably reallocation should be sought. From this perspective, it seems obvious that the pension should be shared 50:50, so they each get the same pension.

Achieving equality of incomes is where the apparent imbalances become apparent. One of the simplest issues arises from the differences in life expectancy between males and females. Statistically, women live longer than men do and annuity rates (the cost of buying a pension income stream) reflect these differences. In short, it costs more to buy a given pension amount for a woman than it does for a man of the same age. To complicate the calculations, there are usually age differences between husbands and wives. All this translates into a need to split a pension other than by 50:50 if the desired outcome is to achieve equality of income in retirement.