Understanding Pension Sharing: Comparing Defined Benefit, Public Sector, and Money Purchase Schemes

Pension sharing is a critical concept in the realm of divorce proceedings, as it dictates how pension benefits are split between divorcing spouses. This blog aims to elucidate the complexities of pension sharing, particularly focusing on Defined Benefit (DB) schemes, comparing them with public sector pensions and Money Purchase (Defined Contribution) schemes.

 Understanding Defined Benefit Schemes

Defined Benefit pension schemes promise to pay a set level of pension benefit, determined by factors such as salary history and length of employment. The benefits of DB schemes include:

Predictability: Members know in advance what their pension will be, providing a stable financial outlook for retirement.

Employer Responsibility: The onus is on the employer to fund the scheme adequately to meet its obligations, reducing investment risk for employees.

Pension Sharing in Defined Benefit Schemes

When it comes to pension sharing in DB schemes, the process involves several key steps:

Valuation: The first step in pension sharing is to value the pension rights. For DB schemes, this is typically done through the Cash Equivalent Transfer Value (CETV), which represents the lump sum value of the pension benefits if they were to be transferred out of the scheme.

Division: Once the CETV is established, the pension can be divided between the parties. This division is not necessarily equal and can be influenced by negotiation or court orders.

Comparison with Public Sector Pensions

Public sector pensions, while also typically DB schemes, have distinctive characteristics:

Non-Fundability: Most public sector schemes are unfunded, meaning they do not have a pot of money set aside to pay pensions. Instead, pensions are paid directly from current government revenue.

Protection: Public sector pensions are generally well-protected and backed by government promises, making them considered safer and more stable.

Valuation Complexities: The valuation of public sector pensions for sharing purposes can be more complex due to the unfunded nature and the specific rules that apply to these pensions.

 Differences from Money Purchase Schemes

Money Purchase, or Defined Contribution schemes, stand in contrast to DB schemes and involve different considerations in pension sharing:

Investment Risk: The investment risk in Money Purchase schemes lies with the individual, not the employer. The value of the pension pot can fluctuate based on investment performance.

Valuation: The valuation of a Money Purchase scheme is straightforward—the current value of the pension pot is what will be shared.

Flexibility: These schemes often offer more flexibility in terms of investment choices and when and how to draw retirement benefits.

Key Considerations in Valuing Pensions for Sharing

Valuing pensions for the purpose of sharing during divorce requires considering several factors:

Type of Scheme: As illustrated, the type of pension scheme significantly affects how it is valued and shared.

Actuarial Valuations: For DB schemes, particularly in complex cases or where large benefits are involved, a more detailed actuarial valuation might be necessary beyond the standard CETV.

Economic Conditions: Economic factors such as interest rates and inflation can impact pension valuations, particularly for DB schemes where long-term liabilities must be assessed.

Legal Framework: The legal framework surrounding pensions and divorce can vary, affecting how pensions are valued and divided. This includes not only the laws pertaining to divorce but also those specifically governing different types of pension schemes.

Wrapping up

Pension sharing in the context of divorce is a nuanced area that requires careful consideration of the type of pension scheme involved. Defined Benefit schemes, whether private or public sector, require a detailed approach to valuation that considers the guaranteed nature of the benefits and the scheme’s funding status. In contrast, Money Purchase schemes offer a more straightforward valuation process but introduce higher risk and variability. Understanding these differences is crucial for anyone involved in a divorce that includes pension sharing, ensuring that both parties achieve a fair and equitable settlement. This knowledge is also vital for financial advisors and legal professionals who assist clients through these complex proceedings.

If you would like detailed advice on your situation, please feel free to contact me for further information.