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Pensions on Divorce

Public sector pensions remedy (McCloud) changes to benefits from 1 October 2023 – implications for Pensions on Divorce settlement

The purpose of this blog is to point out one aspect of the changes taking place for most Public Sector Schemes from 1 October 2023 and as a result of that, what action may be needed.

In general the calculations and results within reports may be invalidated over time due to various factors such as large changes to CEVs. These large changes to the CEVs could be due to things like large salary increases, extra accrual of benefit, the taking of benefits on retirement as well as other reasons. But in addition to these reasons why a CEV may change, a further potential cause has now been added as a result of the regulations coming into force on 1 October 2023 in respect of the Public Sector Pensions Remedy (consequent to the McCloud ruling).

Generalised summary of what to look out for

Action may be required where all of the following conditions apply:

  • A Pensions on Divorce report has been completed, but a Pension Sharing Order (PSO) has not been implemented.
  • A Public Sector pension is involved; so a pension from employment with one or more of the NHS, civil service, teachers, police, armed forces and fire and rescue service. The judiciary has been excluded from this list, because this issue does not arise. Local Government workers have not been included because their scheme has different conditions.
  • The scheme member was an active member of the scheme immediately prior to 1 April 2012 and has some service in the same employment between 1 April 2015 and 31 March 2022
  • The intention is to implement a PSO on that public sector pension.
  • When the report was produced, there must have been two sections to that public sector pension (being the 2015 Scheme section and a pre-2015 Scheme section). The sections are actually referred to as separate schemes. The PSO may only be being applied to one section of that scheme, but the overall pension from both sections together must have accrual of benefit in between 1 April 2015 and 31 March 2022 (inclusive).
  • The report was based on Cash Equivalent Values (CEVs) which were produced before 1 October 2023.
  • A further CEV has been requested after 1 October 2023 but before the PSO has been implemented.

Action required

The parties will need to consider re-visiting the report to assess whether the results are still reliable/valid.

Reasoning

 Any agreed pension share may not work as intended, and could lead to a materially different outcome, because the CEV of the underlying pension in each section may have significantly changed. This change is due to a movement of the benefit accrual for the 2015/2022 period from the 2015 Scheme section to the Pre-2015 Scheme section from 1 October 2023.

I illustrate here a very simplified hypothetical example to indicate what may be happening.

A Pensions on Divorce report has been provided with calculations effective as at 31 July 2023 with a PSO indicated of 50% of the Pre- 2015 pension based on the following CEV values

  • Pre-2015 Scheme section – CEV = £50,000
  • 2015 Scheme section – CEV = £100,000 (£70,000 of this is in respect of the 2015/2022 accrual period)

So the intended share is 50% of £50,000 equalling £25,000 pension credit CEV

The pension scheme member is wondering whether the CEVs may be out of date and so obtains revised CEVs with an effective date of 1 November 2023, which are provided as follows

  • Pre-2015 Scheme section – CEV = £130,000 (£80,000 of this is in respect of the 2015/2022 accrual period)
  • 2015 Scheme section – CEV = £30,000

If a 50% PSO is implemented on the Pre-2015 pension as at say 15 November 2023 then the pension credit CEV would now be based on the new CEVs, and so would become  £65,000 (50% of £130,000), and effectively £40,000 higher than intended.

The cause of the unintended consequence in this example is that, based on the draft legislation published to date regarding Public Sector Pensions Remedy (McCloud), the methodology for calculating Pension Credit and Pension Debit amounts on the application of a Pension Sharing Order (PSO) differs depending upon whether the latest CEV (provided for divorce purposes prior to that Pension Sharing Order being sent to the Pension Scheme) is dated before or after 1 October 2023.

For divorce purposes only, if the latest CEV requested is dated before 1 October 2023, then the PSO would be based on assuming the 2015/2022 accrual had NOT moved to the Pre-2015 Scheme section, and so the pension credit CEV in the above example at 15 November 2023 would still be £25,000.

But if a CEV is requested after 1 October 2023 (or was requested before but is dated after 1 October 2023) then the PSO would be based on the actual re-allocated position of the 2015/2022 accrual into the Pre-2015 Scheme section, and the pension credit CEV would be £65,000 in the example above.

Hence, as a result of the pension scheme member requesting and being provided with a CEV dated after 1 October 2023, the PSO is implemented on a higher CEV of his Pre-2015 Scheme benefits and results in providing his ex-spouse with a greater amount of pension credit than was intended (£65,000 compared to £25,000).

A preventative action to avoid this particular issue could be to ensure that no CEV is requested for these pensions after 30 September 2023 where agreement and financial settlement terms have been negotiated on CEVs issued prior to this date. An undertaking by the pension scheme member to this effect may be considered necessary.

For more details on this public sector pensions remedy (McCloud) and some of the implications of this on pensions on divorce settlements, the position statement on Actuaries for Lawyers website provides further information on this topic (link below)

AFL McCloud Position Statement – August 2023

David Bor

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

Market Movements – What these may mean and what you should watch out for

An important area of concern when dividing up pension rights fairly for divorce settlement purposes has been the large recent changes in inflation, with the Consumer Prices Index (CPI) nearing its highest levels for almost 30 years (according to recent ONS figures). At the same time interest rates have increased significantly over a short period of time with the Bank of England official Bank Rate increasing from a low of 0.1% in December 2021 to 1.25% in June 2022. This can affect pensions settlement in many different ways given the impact on future revaluation rates, pension valuations, and annuity rates. As a consequence of this, there are a number of issues that are worthy of consideration by pensions on divorce practitioners.

Settlements involving Public Sector Pensions

Depending upon how you look at it, some may argue that public sector pension CEVs are less affected by inflation than other pensions encountered in a divorce settlement. The main reason for this is that the Cash Equivalent Values (CEVs) of public sector pensions used in pension sharing are calculated by a factor-based method using valuation factors published by the Government Actuary’s Department (GAD) which are only reviewed infrequently. The majority of the factors currently in use were issued in 2018/19 and use a “real” valuation interest rate, that is “after” inflation, to place a value on future inflation linked pension income streams. The current valuation rate of interest is CPI + 2.4%, that is a “real” rate of 2.4% per annum and this has remained unchanged since 2018. This means that if you are calculating the CEV of an inflation linked public sector pension income of £10,000 per annum, the calculation would remain unchanged at present, irrespective of what future inflation might be.

It should however be remembered that public sector pensions receive inflationary revaluation in April each year, so if CPI inflation indexation is 10% in April 2023, the pension income would increase from £10,000 to £11,000 at that point in time and this would cause the CEV to increase by 10% at that instant. When it comes to pension sharing however, the majority of public sector pensions only offer an internal share to an ex-spouse (requiring the ex-spouse to become a member of the scheme in their own right). The internal share terms are calculated by similar GAD valuation factors used to calculate CEVs  and noting that an internal share calculation is like a CEV calculation but in reverse (an ex-spouse pension income is generated from a CEV credit rather than a CEV being calculated from a member’s pension income) then it is no surprise that the required pension share percentage to equalise pension incomes is unchanged, however both parties will have more valuable benefits post share than had inflation not spiked upwards, as the high rate of CPI inflation means that the actual amount of both their pension income benefits will now be higher from 2023 onwards when the next pension increase is added.

The above points are in generality, and so may not be applicable in all situations for example if the Public Sector pension is not being shared then the current holder of this pension is expected to have a significant increase next April that is not reflected in the current benefit or the current CEV. Another example could be where a pension credit is received just before next April (so in March 2023), then the pension credit member would not benefit from the April 2023 increase.

The cushioning of public sector pensions against being adversely impacted by inflation changes is not repeated in quite the same way for other types of pension arrangements as is considered below.

Defined contribution pensions

Although defined contribution pensions (those for which a fund of money is built up, which can be drawn upon in retirement or used to purchase an annuity in retirement) are the most obviously affected by changing market conditions, this can also make them the simplest to deal with. As the value of such a pension is generally based upon the value of the underlying assets in which the pension is invested, this means that the value of a defined contribution pension may significantly change when market conditions change. The simple point to remember with these, therefore, is to ensure that the CEV to be used is up-to-date (although in the interest of practicality, this can usually be considered to be within a few months of the date of any pension share being implemented noting that any material changes due to additional contributions being made or large drawdown payments being taken should always be considered when agreeing final settlement terms).

Another potential issue with market movements and defined contribution pensions lies in annuity rates, which the Pensions Advisory Group recommends should usually be considered when assessing the likely lifetime income available from a defined contribution pension arrangement. High interest rates makes UK Government Bonds cheaper to purchase and the falling prices of these have seen yields correspondingly shooting up in recent months. As insurance companies selling annuity business can now buy UK Government Bonds much more cheaply to back up their commitments to pay long term lifetime incomes, they are able to offer much more attractive terms to those seeking to buy such annuities. This is good news for those with defined contribution pensions (assuming that valuations of these pension funds have not fallen) as it means that lifetime incomes can now be secured much more cheaply than was the case a few months ago. In recent cases worked on by Actuaries for Lawyers, some annuity rates for annuities with a fixed escalation rate have improved by as much as 10-20% over the last few months, and so the expected annual income available from a pension fund when purchasing an annuity has similarly increased.

Private sector defined benefit pensions

The pension benefits paid out by defined benefit pension arrangements (such as the Railways Pension Scheme, Barclays Pension Scheme, BAE Systems Pension Scheme etc) are also affected by changes in pension revaluation rates before retirement and pension increases in payment as the scheme rules usually require that these benefits are linked to future rates of inflation in some way. In particular, the future pension income available when the pension comes into payment might increase significantly when the pension is revalued between leaving service and retirement.

One key area of difference however between private sector defined benefit pensions and public sector pensions however, is the very different method used for calculating CEVs. When private sector defined benefit pension CEVs are calculated, the scheme actuary is obliged to have some regard to future market conditions when making recommendations to the trustees of the scheme as to actuarial assumptions to use when placing a present value on the future pension income available to a scheme member. The assumptions used will be dependent on the investment strategy adopted by that particular scheme which in turn depends on a number of factors, such as the funding position and maturity of the scheme. The general principle used when calculating a CEV is to estimate the amount of money needed at the calculation date to pay the future pension benefits due to be paid to the member when they fall due. These assumptions are required to match the changes in market conditions. For example, on a recent case Actuaries for Lawyers saw a pension scheme provide a CEV in mid-2020 of around £800,000 which dropped to a more recent CEV of around £700,000 mainly due to a change in the Scheme Actuary’s assumptions of future market conditions (in this case, the most significant such condition is likely to be the assumption of future investment return).

This change in CEV means that the pension credit available to an ex-spouse following the implementation of a pension share may change materially if market conditions experience significant change. This may mean that on cases where a significant portion of the parties’ pension rights (which may be subject to a pension share) are held in a private sector defined benefit pension scheme, it might be prudent to obtain an up to date CEV if there has been a material change in the yields on medium dated UK Government bonds since the previous CEV was calculated, even if the latest CEV is less than 12 months old and there may even be a fee charged to obtain an up to date value. This is the position we are in at present as in the last few months, there have been considerable movements in the financial markets due to factors such as the significantly increasing price of energy, the war in Ukraine and consequential significant increases in CPI and RPI measures of price inflation over the past 12 months.

These issues as well as other factors have caused the yield of 20 year Government bonds to increase to a high of around 2.5% per annum at the beginning of June 2022.  Whilst this may all appear quite technical, what is important here is the implication of the above on the calculation of CEVs.  As CEVs are effectively placing a discounted present value on the pension income stream from the member’s normal retirement age until their eventual date of death, the higher the yield on Government bonds, the higher the discount used when placing a present value on future cashflows arising from their pension and consequently the lower the CEV would be expected to be.

When it comes to pension sharing calculations, there will undoubtedly be overlap between some of the observations highlighted above. Hence the reduction in a private sector CEV being subject to an external pension share may result in a higher pension share percentage being required to equalise pension incomes, however this may be countered to an extent by the better annuity rates now available to the ex-spouse reducing the required pension share.

Which of the above factors may dominate may be difficult to predict and will vary based upon the circumstances of the case which is being considered.  The issues highlighted here underline the importance of obtaining expert advice from a pensions on divorce expert so that the possibility of unexpected consequences occurring following a pension share can minimised.

Joseph Lennard

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.

Uniformed Public Sector pensions and pension sharing – what should you look out for?

Uniformed public sector pensions – the Police Pension Scheme, Firefighters’ Pension Scheme, and Armed Forces Pension Scheme – can be tricky to consider when pension sharing is a likely method of settlement to be used. The biggest issue to look out for is the retirement age that is to be used in any calculations, since the party who holds the Uniformed Services pension may be able to retire at an earlier age than their ex-spouse would be able to retire at from any credit pension awarded to them, especially in the older legacy schemes (the Police Pension Scheme 1987, Firefighters’ Pension Scheme 1992, and Armed Forces Pension Scheme 1975).

Uniformed Services pensions may allow the member to retire from active service on an unreduced pension, as early as attaining 30 years’ service (potentially in their late 40’s) on Police 1987 cases, from age 50 in the Firefighters’ 1992 Scheme and even earlier, potentially from as young as age 37, in the Armed Forces Pension Scheme 1975. The ability to benefit from these favourable terms usually requires the member to retire from active service (that is as a current employee) of the uniformed service in question and further stipulates that they have completed a minimum period of service. In these schemes, the credit pension is not usually payable to the ex-spouse until their age 60 or 65 without reduction and so a simplistic approach such as equalising the Cash Equivalent Values (CEVs) of the parties’ pensions can lead to unexpected and arguably unfair outcomes.

The “minimum period of service” point above is very important to remember as this impacts on the assumed date of retirement when the CEV is calculated which in turn means that the CEV of the pension can change quite dramatically when a service milestone date is reached. For example, when a police officer in the 1987 Scheme reaches 25 years of qualifying service, their 1987 pension will become payable from age 50 (or immediately if they are above this age) which can cause the CEV of their pension to increase quite significantly at this point. This happens because before reaching 25 years of service, their pension is only payable without reduction from age 60 and so on reaching 25 years of service, there are now potentially another ten years of possible pension payments to be included in the valuation calculation. This again can result in unexpected outcomes, particularly if there is a lengthy delay between the calculation of any necessary share and the implementation of that pension share. If the member is expected to remain in service until their retirement, it could also be argued that their pension should be given a higher value to account for the expected reduction in normal pension age on reaching their service milestone date, though there may always be arguments as to whether they will certainly remain in service long enough to reach the milestone date and consequently gain from the more favourable pension benefit terms.

In addition to differences in the parties’ future pension incomes due to their differing retirement ages, there can also be the issue of Early Departure Payments (EDPs) in the Armed Forces Pension Scheme if the husband or wife in a divorce settlement is a member of the Armed Forces Pension Scheme 2005 or 2015. EDPs comprise of a tax-free lump sum and regular income payments made from the date at which the member leaves service in the Armed Forces provided that this is after their 40th birthday but before their assumed Normal Pension Age and they have completed at least 18 years of service (to qualify for Armed Forces 2005 EDPs) or at least 20 years of service (to qualify for Armed Forces 2015 EDPs). The regular income payments would be paid until age 65 (for Armed Forces 2005 EDPs) or until State Pension Age (for Armed Forces 2015 EDPs). One key point here however is that EDPs are not considered pension rights by the Scheme. Consequently, although these may be a source of income that an ex-spouse may “lose the chance of acquiring” post-divorce, they are not affected by any pension sharing order made on the Armed Forces 2005 or Armed Forces 2015 Schemes or included in any CEV calculated by these schemes. This means that it might be necessary to consider periodic payments to the ex-spouse, or possibly to make an adjustment to the required pension share in order to allow for the difference in future income post-divorce, though the extent to which this might be reasonable could be influenced by post-divorce employment income and other income expected to be received by both parties.

A number of other issues could be significant too, for example if a member has retired in ill health and has a non-shareable injury pension included in their pension rights or if a member of the Armed Forces has recently become a commissioned officer (after originally joining the Armed Forces at a non-commissioned rank, referred to as an “other ranks” member). Due to these potential issues, it is usually advisable on cases including a uniform public sector pension to obtain a report from an appropriately qualified pensions on divorce expert.

Joseph Lennard

Actuaries for Lawyers

About the writer

Disclaimer – The views expressed here are the views of the writer only and do not necessarily represent the view of Actuaries for Lawyers. Whilst every effort has been made to ensure the accuracy of the information in this post, it is important to always check the benefit rules with the schemes before making any financial decisions based upon these. Actuaries for Lawyers cannot be held responsible for any losses incurred as a result of relying upon information contained in the blog section of our website as these do not constitute advice or act as a substitute for providing individual advice in relation to the specifics of a particular case.