A mistake many people make when deciding what assets to split during divorce proceedings is to split the value of Final Salary pension benefits based on the Cash Equivalent (CE).
The CE is the monetary value a scheme’s actuaries will place on the value of benefits the divorcing member has accrued to date and are calculated based upon assumptions including growth rates, inflation and life expectancy.
It is a mistake to base negotiations solely on the CE for a number of reasons:
· Pension funds are illiquid assets; they can’t be accessed until age 55 at the earliest and then only 25% of the fund is available as capital. It may therefore be more appropriate to consider them in isolation to non pension assets.
· A pension fund equates to a promise of capital and income in the future which is difficult to put in today’s terms. The CE is by definition the actuary’s opinion of what a future pension is worth and will therefore vary from actuary to actuary depending upon the assumptions used.
· The income split available from a pension is also unlikely to be equitable. The income the recipient spouse can receive from his or her pension share will be based upon their age, gender and the prevailing annuity rates available at the point of retirement. A younger female spouse would therefore need a larger share of a pension fund to produce the same level of income.
· A younger spouse would have longer to build up a larger fund and therefore a greater income in retirement.
· The pension that is being split may have particular benefits that are lost on transfer; Guaranteed Annuity Rates that are much higher than those available currently or an annually increasing income for instance. Or, there may be penalties applicable on transfer from a scheme which would reduce the value of the CE.
· Defined benefit schemes typically pay out higher annual incomes than do private pension annuities purchased by the spouse who received the share.
· The spouse giving up the pension benefits may argue that part of the accrual was before the marriage and so should not be accounted for in the share.
· Certain professions, such as the army and police force, are able to access their occupational pension funds sooner than the typical retirement age of 65. A share of a pension on this basis would see the recipient spouse unable to access their share until later and therefore a share calculated on the CE may penalise the member.
Taking into account these factors a fairer approach to negotiating pension settlements on divorce is to seek equality of income rather than capital and calculate back from this position what share of the pension fund this equates too.