When a couple decides to dissolve their marriage or civil partnership, many people think that the family home is the most important asset to distribute. However, pensions are often neglected – despite the fact that these might actually be more valuable than the equity in the property.
Divorce is an unpleasant topic and pensions are often one of the last things on people’s minds when they are going through this traumatic process. However, it is hugely important as it will affect your income and lifestyle in retirement.
In this short guide, our financial advisers will point out some of the important areas of pensions which you must take into consideration when going through a divorce.
If you need to speak to an adviser about your specific situation, then we invite you to get in touch and arrange a free, no-obligation phone consultation with one of our team.
Divorce: What happens to pensions
Many people freely admit that they do not know how pensions are dealt with during a divorce. As a result, pensions are often neglected within divorce settlements.
Some people assume that each person keeps their own pension when a couple divorces. A smaller minority believe that the pension pots are split evenly. The reality, however, is usually more complicated than either of these scenarios.
Here are some of the ways pensions can be approached during a divorce case:
#1 Deferred lump sum
For those living outside of Scotland, sometimes this is the arrangement agreed upon. When the pension-holder dies, the other person receives a lump sum.
This sometimes occurs in divorce cases where the husband has been the breadwinner and holds a large pension. The wife, however, spent most of her adult life as the home-maker and has little/no pension funds.
#2 Pension sharing
Sometimes, the court will decide that a deferred lump sum is not appropriate in a divorce case. Instead, it might decide that the pension in question be shared.
Sometimes, the value of the pension (or part of it) is offset against the value of another asset such as the family home. For instance, if the wife might keep the family home and the husband moves out, then the value of the equity in the home might be offset against the value of his pension. This can all get very complicated, however, as it is not always straightforward to compare the value of different assets such as property and pensions.
Moreover, pension offsetting isn’t always an option for divorcing couples. For instance, if the wife has no pension and is close to retirement age, then she might not agree to keep more of the equity in the home in exchange for the husband keeping more of the pension.
#3 Earmarking the pension
One approach to consider when dealing with pensions during divorce is to earmark the pension, which hands one of you an income/lump sum when the other person draws from the pension.
This might be a sensible option in particular cases. Yet you need to be aware that if the pension-holder defers drawing from the pension, then you will likely not receive the income/lump sum you need in retirement at the time when you expected it.
Moreover, please be aware that if you remarry and were previously depending on income from an earmarked pension, then you will likely stop receiving this income. Furthermore, you will also stop receiving the income when your former spouse dies (unless you have taken out a life insurance policy).
Deciding how to deal with pensions in your own situation
It is beyond the scope of this article to specify exactly how to deal with the pension(s) in the reader’s own particular situation. There are many different kinds of pensions, first of all, some of which are fairly simple whilst others (e.g. final salary pensions) can be immensely complex.
Moreover, some couples might not value the importance of pensions during a divorce case. Or, one person might value them more than the other person, which could affect the settlement.
What we would say is that neither person in the dissolving union should ignore or neglect the importance of the pension arrangements. It helps nobody for either person to face pension poverty or financial difficulties later in life.
Although all divorce cases are different, one of the first things you should do is ascertain the value of your pension(s) to date. If you have contributed to one or more workplace pensions, for instance, then you should work with a financial adviser to find out how much these pots are worth. You then need to combine these with your state pension entitlement.
Quite often, the total value of your pension pots will be worth less than what you might expect, since you will almost certainly face penalties/charges for transferring from the scheme.
Once you know how much value is in your pension(s), you then need to sit down and calmly figure out which options appear most appropriate for your situation. Do not make any big decisions rashly or out of emotion.
Women in particular need to take special care during divorce proceedings, as women tend to have fewer retirement savings than men (e.g. due to lower earnings and years devoted to child-rearing). Make sure you do not focus on the family home so that you neglect the pension arrangements, as you do not want your retirement to needlessly suffer after your split.
As always, in complex situations like this involving life-changing decisions and money, we recommend that you consult with an experienced, independent financial adviser. Although this is an additional expense during an already costly time of your life, it will help you make the most rational decisions about your future based on expert advice, hard facts and solid information.