Do you know where your Pension stands in a Divorce Case?

At Hylton-Potts, we deal with a lot of concerns surrounding divorce proceedings and what people are entitled to. One concern which crops up on a regular basis is whether their partner has a right to any of their pension, and how exactly this is valued.

We would always prefer people to get in touch with us, as every situation is unique and so are the proceedings, but below are the main things you need to know about, where pensions and divorce are concerned.

What do pensions mean in a divorce?

It might surprise you to learn that a pension income is not a realisable asset of an individual, because it cannot be encashed. However, when a person is undergoing divorce proceedings, a cash value is required, and in this case a Cash Equivalent Transfer Value (CETV) is used to determine it.

This occurs even in the circumstance where the pension is already in payment and a CETV cannot be paid, as the person in question doesn’t have the right to transfer the benefits to another pension arrangement.

There are many variables and unknown factors when it comes to pensions in a divorce, which is what makes them so hard to place a CETV on. For one thing, a person’s pension comprises of a series of future cash flows, which means the capital value is unknown while the individual is alive, as it depends entirely on how long he or she lives. To make matters even more confusing, pension payments can also be linked to price inflation, which introduces further uncertainty as, of course, future price inflation is unknown.

In the event of a person’s death, pension payments can still continue after their demise to a spouse or other dependant, so again this adds to the uncertainty of placing a capital value on the cash flows.

How is the capital sum calculated?

Due to all of these variables, calculating a final amount can be tricky. This is why when calculating the capital sum needed to provide a future income stream, an allowance is made for the investment returns that the capital sum might achieve, while it is gradually disinvested to provide the income.

Based on this, when calculating a CETV, allowance is made for the future investment returns that might be achieved by the pension scheme assets.

A CETV is therefore calculated by a pension scheme using best-estimate assumptions, which are based on the cost to the scheme of providing the benefits for the membership as a whole.

Generally, no allowance is made for an individual’s circumstances. Unfortunately, this means that there are several assumptions about the future which might not be appropriate when considering the value of an individual’s future pension income from their perspective.

What are the main assumptions made?

There are many assumptions that must be made if a reasonable CETV is to be calculated, and these can roughly be divided into three main areas.

1. The investment return assumption

This is used by the pension scheme based on the underlying investments held to provide the pension income. Often, it is long-dated, fixed-interest investments that are held for this purpose.

By contrast, an individual holding assets to provide future income for herself/himself may well invest in other asset types, depending on his/her overall financial situation and attitude to risk.

Currently, the investment returns on long-dated fixed interest investments are significantly lower than the future investment returns expected from a broad range of asset types, that might well be held by an individual investing a capital sum to provide future income for himself/herself.

A low investment return used to calculate a CETV, places a high value on it. If this high CETV is invested by an individual to provide an income for himself/herself, it will be more than is required, as he/she is expected to achieve a higher investment return. However, the capital value of the person’s pension income based on a broad range of asset types is likely to be lower than the CETV under current conditions, all else being equal.

2. The member’s longevity

Another assumption made to calculate a CETV is with regard to a person’s longevity, based on a standard table of mortality patterns for all pension scheme members.

However, no allowance is made for an individual’s circumstances, so if there is reason to believe that a member’s life expectancy is lower than the standard table’s, the CETV calculated for him will be too high.

Possible reasons for this include family history, lifestyle (such as dangerous hobbies, or an overindulgence when smoking or drinking) and state of health.

3. Surviving spouses or dependants

A pension scheme often provides income to a surviving spouse or other dependant following the member’s death. When calculating the CETV, the same assumptions are often made for all the pension scheme members, including:

1. that 90% of them have a surviving dependant of the opposite gender and…
2. that a male is three years older than a female

Depending on the exact definition and circumstances where a member has a dependant, the CETV may be slightly too low.

Where a pension for life becomes payable to a dependant who is significantly younger than the deceased member, the pension scheme rules may allow for a reduction to the amount payable, in order to limit the scheme’s liability.

The CETV assumes a three-year age difference, but a calculation allowing for the true age difference can allow for the reduced pension amount, so there may be a significant difference between the two calculations.

Summary

The calculation of the capital value of a person’s pension income is a tricky process with uncertain results, because of the assumptions that must be made about unknown future events.

The assumptions used to calculate the CETV may not always be appropriate to the individual’s circumstances, and under current conditions, the CETV is likely to be higher than a person’s real circumstances, based on the investments that might be held by an individual.

Because of the difficulty in navigating these waters, it is always best to seek the advice of a professional. At Hylton-Potts, we’ve helped hundreds of people deal with these difficult processes while they are undergoing the stress and anxiety that going through a divorce can evoke.

If you’d like more advice on this, then you can call us on 020 7381 8111, or send us an email at [email protected].

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