This is one very frequently raised question when parties are trying to resolve financial issues during divorce or dissolution of a civil partnership. Despite there being no legal definition, ‘offsetting’ is the term used to describe this exchange in the context of pensions on divorce. Let’s look at what offsetting is and how it works in more detail.
What does it mean to ‘offset’?
Offsetting refers to one way the court can into account one party to the divorce / dissolution retaining their pension benefits as a trade against when considering the distribution of other available assets between the parties on divorce. It could also be described as the ‘trading’ of assets. It is an increasingly popular approach.
Can you give an example?
When negotiating financial matters pertained to a divorce, you would expect to see one party proposing to take a larger share of the equity in the house and the other might retain cash or investments in lieu of that.
Pension offsetting is similar in that one party would retain either all or more of the pension asset in lieu of another capital asset that will be retained by the other party, more usually the family home.
Is offsetting a type of pension order?
Unlike either pension sharing or pension attachment, the court cannot order pension offsetting. There must be agreement between both parties that they wish to offset the pension
So it’s a simple trade off – I get the pension and she gets the house?
From the outset, it is important to stress that pension assets cannot be treated in the same way as cash in the bank. The value of pension funds cannot therefore be easily compared to other assets on a pound for pound basis. Pension funds cannot be accessed in the same way as a bank account and it can be very difficult to understand the true ‘value’ of the fund. It is of paramount importance to understand the ‘value’ that is being acquired, lost, or retained to ensure that the set-off is fair.
How do I figure out the value of my pension?
Offsetting can be complex. In most cases expert opinion will be needed from a specialist pension actuary. The instructed pension actuary will calculate what amount of pension asset is needed to be offset against the other available capital asset(s).
How does this work in practice?
An expert pension actuary will provide an opinion report which will:
(a) determine the accurate values of the pension fund(s);
(b) consider how much of another capital asset (example available equity in the family home/ another property) would be appropriate to ‘offset’ one party retaining their pension assets.
What next?
With the benefit of the expert opinion, the parties can consider how much (and what other) of the capital assets will be retained by the other party in lieu of the pension funds. A financial order can then be made reflecting the division of assets in accordance with this offset.
What considerations should be taken into account when offsetting?
The pension must be valued accurately.
In most cases a pensions on divorce expert (PODE) should be instructed to calculate the offset value.
Consideration should also be given to the tax that will be paid when drawing the pension asset and also number of years it may be before that party can actually access the funds in the pension and, if required to wait for a period of time, how this might impact the offsetting amount.
In recent guidance on the subject it is suggested that the discount that might be applied for tax and utility purposes could be between 20-40%.
N.B. Offsetting is only an option where there are sufficient other capital assets to offset against!
Is there more than one way of calculating offsetting?
Yes there are many ways of calculating set-off and the courts have not chosen one particular way of approaching the calculation. It will vary from case to case as the court will have to consider many factors when deciding what is fair and equitable.
Can we calculate the appropriate offset value without the need for an actuary ?
Yes. However we would advise proceeding with caution.
If you have instructed a solicitor to advise you they will be noticeably reluctant to proceed to advise you on an appropriate offset amount especially if the pension(s). That is because there is no exact science to calculation of the most appropriate offset.
Offsetting may produce an unfair trade off and could leave one party with less than a fair share of the overall assets.
Does it matter what sort of pension(s) I have?
Yes, absolutely. Your solicitor would need to consider the type of pension scheme being considered – defined benefit scheme or defined contribution scheme. It is not appropriate to compare ‘like for like’ when looking at these two separate scheme types.
If affordable, it is always best to involve an actuary if you are looking at a defined benefit scheme with a CE value of £100,000 or more. There is simply no substitute for expert advice geared to your own specific set of circumstances.
What if offsetting is not appropriate in my case?
Offsetting is only one of three main options for splitting a pension.
Pension Sharing
The second option is known as Pension Sharing. In pension sharing a portion of a pension fund is separated and placed in a pension pot for the other party. The transfer can be internal or sometimes external and there is a fee for implementation of the Pension Sharing Order.
Like offsetting, a Pension Sharing Order offers a clean break to parties. It is also an affordable option if parties don’t have sufficient alternative capital assets to offset against their pension.
Pension Attachment
The third option is Pension Attachment and it is a much less frequently seen arrangement whereby the transferring party retains their pension until they are able to drawn down at which point the pension provider pays a portion to the recipient party.
It is not a particularly popular option as, amongst other things
(a) it leaves the recipient beholden to the transferring party on draw down and
(b) if the transferring party dies the attachment order comes to an end and
(c) the parties cannot achieve a clean break.
Pension Attachment Orders do however allow for the pension income and tax-free cash lump benefit to be ‘earmarked’. Also, also death in service benefits can be set aside.
The most obvious difference between earmarking and sharing is that there is no legal transfer of ownership when earmarking.
Is offsetting the best way for me to deal with pension issues during my divorce?
That depends entirely on the circumstances of your specific case and on its own merits. Parties often prefer offsetting rather than each asset being sold and then divided between them.
There are also circumstances where a pension share is not an option (for example when dealing with an international pension) or where it would be ill advised (for example where there is a significant income or age gap).
However pensions are very distinct to other capital assets and a careful approach must be undertaken to ensure that any proposed set-off is properly assessed to ensure that a fair outcome is reached.
Pros of Offsetting
- Quick and simple
- Can provide a clean break
- By agreement of the parties
- No implementation or associated fees might mean more cost effective (depending on the size and type of the pensions)
- Pension owner retains their pension funds in their entirety
- Receiving party can immediate use of capital rather than waiting for a pension share effective on retirement
- Works for foreign pension assets which cannot form part of a pension sharing order arrangement in England & Wales
- Receiving party less likely to pay tax on the offset sum
Cons of Offsetting
- Might result in little – no capital access for the pension asset retaining party
- Can’t be court ordered / mandated
- It can be difficult to compare different forms of assets – like the home and pension
- Pensions on divorce experts have no single agreed formula for calculating offsetting
- Potential for longer term income issues without sufficient provision for retirement
- Can often be impractical or unaffordable
Summary
- This is a very complex area of law.
- Using available equity in a property to ‘offset’ a pension claim requires very precise attention.
- If affordable you should seek assistance from a specialist family lawyer who understands pensions on divorce.
- You will very likely need to obtain an opinion from a pensions on divorce expert (‘PODE’) to review your pension(s) and calculate the fair pension split in your particular circumstances.
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