When you’re agreeing a financial settlement on divorce, pensions are likely to be one of the key assets. A pension can be among the most valuable assets to be split when your marriage ends, and there are several ways that pensions can be dealt with in your financial agreement. One option is ‘pension offsetting’. But what is pension offsetting? How does it work? And how do you value a pension for the offsetting process? Keep reading for our guide to pension offsetting on divorce.
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What is pension offsetting?
If you are going through a divorce, splitting your assets and property is one of the key steps. Pensions can be a complicated asset to divide when your marriage ends, and so one of the options open to you is to use ‘pension offsetting’.
Pension offsetting involves treating your pension as a single asset. When you divorce, all your assets, and all those of your ex-spouse, are taken into account. When you come to divide your assets, one of you would keep the pension while the other spouse is allocated other assets of the same or similar value.
For example, if you have a significant pension then you may receive this in the settlement while your spouse receives the marital home (assuming they are of a similar value). The value of your pension is ‘offset’ against other assets.
It can be a useful option if one party wants to keep a significant asset such as a property while being prepared to give up any rights to a future pension. Additionally, pension offsetting can be used if you have overseas pensions which can’t be shared using a court order in the UK.
How does pension offsetting work?
Here’s how pension offsetting works.
Firstly, the total value of all you and your spouse’s assets will be taken into account. This includes both pension and non-pension assets such as property, savings and investments, as well as all income being received. This establishes a total value of all assets.
Then, the value of your pension can then be offset against other matrimonial assets. You’ll retain all your pension rights, while your spouse will receive assets of the same/a similar value as your pension. This may be property, or other assets such as savings.
Do I need to go to court for pension offsetting?
No. You and your spouse can agree to divide your assets and offset your pension arrangements without a court order.
If you want to use other methods of dividing pension assets, such as a pension attachment order or a pension sharing order, then you will have to go to court.
This means that pension offsetting can be one of the most simple and straightforward ways of obtaining a ‘clean break’ when you divorce. However, it might not be the most appropriate method for you as you may benefit from assets in the short term while losing valuable pension benefits in the long term.
In what circumstances could pension offsetting be appropriate for me?
There are several reasons that pension offsetting may be appropriate for you:
- Your pension assets are relatively modest – perhaps you’re quite young and you don’t have a lot of pension assets? If so, getting a pension sharing order or a pension attachment order may be prohibitively expensive bearing in mind the value of your pension fund
- You have sufficient other assets to offset the pension
- Your ex-spouse has enough retirement income and so does not need any additional pension benefits
- A spouse may have a greater need for cash or assets now as they need to move home, buy furniture for a new property, or buy items for themselves or the family
- A spouse’s priority is to retain the marital property and is prepared to give up pension rights to secure this.
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How is a pension valued for offsetting purposes?
One of the challenges when using pension offsetting is establishing a value of the pension. They are not a fixed asset, and as there are many different types of pension it can be hard to work out what one is worth, so it can be offset against other assets. £10 in a pension is not necessarily the same value as £10 in a savings account.
No single method of valuing a pension has been agreed by the court. Initially, the calculation normally starts with obtaining a Cash Equivalent Transfer Value (CETV) which establishes the base value of a pension.
Then, a ‘utility discount’ is often applied to the pension value. This reflects the advantage of being able to take a cash asset straight away rather than waiting for a pension benefit in the future. This normally gives a value to the pension for offsetting purposes.
Problems with this approach are:
- A Cash Equivalent Transfer Value can often underestimate the true value of a pension when it is taken on retirement
- There is no fixed or agreed approach to the ‘utility discount’ as there is no clear value to accessing cash assets straight away rather than wait for pension benefits in the future.
Examples of how pension offsetting can work
Here’s an example of how you could use pension offsetting to divide your assets on divorce.
You own a marital property worth £150,000, with no mortgage. You have a pension with a Cash Equivalent Transfer Value of £250,000. Your spouse has a pension with a Cash Equivalent Transfer Value of £40,000.
One solution here is for your spouse to keep the marital home, and for the excess value of the pension to be shared. The excess value of pensions is £210,000 (the difference between the value of the two pensions) less £150,000 (the value of the property) = £60,000.
If half of this pension were to be transferred to your spouse, they would receive £30,000. This is equivalent to a 12% share of the pension (£30,000 divided by £250,000).
The assets after divorce would be:
You – 88% of your pension. Total: £220,000
Spouse – Marital property (£150,000), 12% share of your pension (£30,000) and own pension (£40,000). Total £220,000
This is a simplified example as, in reality, £10 of Cash Equivalent Transfer Value in pension assets is not likely to be equal to £10 in other assets.
Here’s another example:
You jointly own a marital home worth £200,000 and your pension is worth £100,000. Your spouse has no pension. The court wants to split assets 50/50.
The court may decide that you can keep your pension, but that your spouse is now entitled to £150,000 of the house proceeds.
You each benefit from £150,000 in assets.
What advantages does pension offsetting have against other options such as pension sharing or pension attachment orders?
There are seven main advantages to pension offsetting compared with other options such as pension sharing orders or pension attachment orders:
- It means that one party can benefit from assets for which they have a greater need (for example, the marital home or cash savings)
- It is a cheaper option than other types of order, making it more cost-effective if you don’t have significant pension assets
- You don’t have to go to court to obtain an order
- It is likely to lead to a better outcome in a situation where both of you already have significant pension assets and where you don’t need to split your pensions
- It is relatively simple and gives you a clean break on divorce
- If you’re the spouse who has taken the ‘offset’ assets, you receive the benefit of these assets immediately rather than being subject to fluctuations and uncertainties in the value and performance of a pension scheme
- Pension offset is not affected if one spouse remarries or dies.
What are the disadvantages of pension offsetting?
While there are a number of advantages to pension offsetting, there are some factors you should consider:
- You may end up with no pension asset if you give up these rights to benefit from other asserts. This means that you could end up with a low income in retirement, particularly if you have stayed at home to look after children. It may be difficult for you to build up a sufficient pension fund
- It can be hard to decide on what is a fair split. As there is no hard and fast rule for valuing a pension, coming to an acceptable split can be a challenge. Pension values can fluctuate more than other assets which means it can be hard to agree on a value
- Your pension assets could be worth significantly more than other assets. This can make it difficult to divide assets successfully. Offsetting may not therefore be the most appropriate way to divide your combined assets
- You will lose any life insurance benefits under the member’s pension if you decide to take other assets.
Do you need help with your divorce?
Get in touch now with one of our panel of specialist local family solicitors.
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