Pensions can be one of the more complicated parts of reaching a financial settlement on divorce. Different types of pensions work in different ways, and the figures provided by pension schemes cannot always be compared directly.
A pension sharing report helps to make sense of those differences. It looks at the pensions held by both parties on a consistent basis and, where appropriate, calculates how they could be shared to achieve the outcome requested.
This guide explains the key parts of a pension sharing report, what the calculations are designed to show and what the figures mean, so you can approach the report with a clearer understanding of what you are looking at.
Types of Pension
Pensions come in two main types, which look and feel very different from each other:
Defined Benefit (DB) pensions give a promise of an income in retirement. “When you reach ‘such’ an age, you will receive ‘this’ much pension each year, which will increase in ‘this’ way”. With a DB pension, the income is known, but its comparable value is not.
Each pension scheme running a DB pension will provide its own valuation, the Cash Equivalent Transfer Value (CETV), but CETVs from different schemes are not necessarily calculated on the same basis. Two pensions promising the same retirement income can therefore have very different CETVs.
Defined Contribution (DC) pension works the other way around. Its current value is known, because it is an investment account. What is not known is how much retirement income that fund could provide.
The report looks at the pensions built up to the calculation date. Very rarely will it make allowance for pension benefits that may be built up in the future. Because DB and DC pensions work differently, the information we need for each pension is different.
Pension Sharing Report Part 1: Working Out The Gap
Before we can compare the pensions fairly, we need to put them all onto the same footing.
For every pension, we calculate two things at the same date and on a consistent basis:
- the retirement income it provides; and
- its value.
In simple terms, we fill in the missing half of the picture. For a DB pension, we already know the income, so we calculate the comparable value. For a DC pension, we already know the value, so we project the retirement income it could provide. The calculations use the same assumptions, so every pension can be compared on a like-for-like basis.
We can now compare the pensions and work out the gap between them – once we know the size of the gap, the report moves to part two.
Pension Sharing Report Part 2: Calculating The Share
Once we know the size of the gap, the next question is much simpler: which pension should be shared, and by how much?
Which pension to share?
The person with the lower pensions will keep the whole of their pensions.
For the person with the higher pensions, we look at each of their pensions in turn to see what pension credit would be available for every £1 a year shared. The pension that offers the highest pension credit is most efficient and will usually be the one used for pension sharing. If there are a few options that may be preferable, we would explain the choice and provide alternative sharing options to consider.
An efficient share can benefit both parties: the person giving up part of their pension can expect to share a smaller percentage, while the person receiving the pension credit can expect to receive more retirement income.
Calculating the result
Pension sharing is now calculated, and the answer will be expressed as a percentage of a specified pension, not a fixed sum of money. The court will approve the percentage to be shared. The actual amount transferred will depend on the value of the pension when the order is implemented.
Equal value or equal income?
The report will answer the questions raised in the letter of instruction. The aim is for equality – but what does “equal” mean in practice?
We might be asked to calculate sharing which provides:
- Equal retirement incomes (based on retirement at a particular age), or
- Equal pension values
These will usually produce different pension sharing percentages because they are answering different questions.
If you want only one answer to move forward, equal retirement incomes are often the starting point*.
* There can sometimes be good reasons to consider pension values as well or instead, particularly where the pensions are complex (for example, uniformed services pensions), where there is a substantial age gap, or in high-net-worth cases.
The retirement ages allowed for in the report should, as far as possible, be fair to both parties. If you haven’t yet reached retirement age, allowing for you both to retire at the same age is often a sensible approach.
Do we need any additional calculations?
We are sometimes asked additional questions, which can include:
- Offsetting calculations – where non-pension assets, often including the family home, may need to be divided in a way that isn’t equal. Sometimes, taking – for example – more equity in the house but a lower share of the pension can enable both parties to move forward.
- Taking into account only those pensions built up within the relationship period,
- The sharing needed to equalise incomes at alternative retirement ages.
It is usually helpful to keep the questions in the letter of instruction focused. Each additional scenario usually doubles the number of figures in the report. Although extra calculations can sometimes be useful, as well as making the report more expensive, we find too many alternatives can be harder rather than easier to reach an agreement.
What happens when pension sharing is agreed?
Once pension sharing has been agreed, the court makes a pension sharing order stating the percentage to be transferred of a specified pension. This is then sent to the pension administrator, who has up to four months to implement it.
The actual amount transferred will only be known when the order is implemented, because it will be the agreed percentage of the pension’s value at that time.
Once pension sharing has taken place, there is a clean break. The pensions are now owned by each of you independently of each other.
What the report does – and does not – do
The report is not a retirement plan. It does not tell either of you when to retire, how to invest your pension, or what decisions to make many years from now. Its job is much narrower: to calculate the pension sharing required to achieve the outcome requested in the letter of instruction.
Once the financial settlement has been agreed and any pension sharing order implemented, the report has done its job.
At Excalibur, our role is to make complex pension matters easier to understand, providing clear, independent actuarial advice to help you move forward with confidence.
Nicola Hooper-Greenhill
Fellow of the Institute and Faculty of Actuaries
nhoopergreenhill@excaliburactuaries.co.uk
Nicola is a Chartered Actuary and PODE who has helped hundreds of divorcing couples deal with differences in their pensions.
She has extensive experience of pension sharing involving complex schemes such as Royal Mail, Universities, Railways, the Pension Protection Fund and public sector pensions, including Armed Forces, Police and Firefighters. She has a particular interest in working with couples who are both self-representing.
Nicola takes a collaborative approach, listening carefully to clients and providing personal, pragmatic advice tailored to their needs.