Pensions are often the "elephant in the room" during a divorce. While the family home usually takes centre stage in negotiations, the pension pot is frequently the second largest asset in a marriage—and in some cases, it is actually the largest. Yet, it is often the most misunderstood, undervalued, and overlooked element of a financial settlement.
At D&A Solicitors, we see many clients who are understandably focused on the immediate future: where they will live and how they will pay the bills next month. However, a divorce settlement is not just about surviving the next year; it is about ensuring your security twenty or thirty years down the line.
Following the recent shifts in the UK tax landscape, particularly the changes to how pensions will be treated for Inheritance Tax (IHT) from 2027, the way we approach pensions in divorce has become more technical and more critical than ever before.
Here is a comprehensive guide to how divorce affects your pension and why you cannot afford to ignore it.
The Hidden Asset: Why Pensions Matter
In the heat of a separation, it is easy to see a pension as a distant, abstract concept. Unlike the family home, you cannot live in it, and unlike a savings account, you cannot usually withdraw it tomorrow.
However, the "Cash Equivalent Value" (CEV) of a pension can be substantial. For couples who have been married for a significant period, or where one party has had a long career in the public sector (such as the NHS, police, or civil service), the pension pot can easily be worth hundreds of thousands of pounds.
If you walk away from a divorce without addressing the pension, you may find yourself "house rich but cash poor" in retirement. We have seen cases where one party keeps the family home but is left with almost no retirement income, while the other party keeps a massive pension that provides a comfortable lifestyle in later years. Our goal is to ensure a fair distribution that reflects the needs of both parties in the long term.
The Three Main Ways to Deal with Pensions
Under the laws of England and Wales, there are three primary methods for dividing pension assets. Each has its own advantages and potential pitfalls.
1. Pension Sharing
This is currently the most popular method because it allows for a "clean break." A Pension Sharing Order (PSO) is made by the court, which instructs the pension provider to take a specific percentage of one party’s pension pot and transfer it into a new pension pot for the other party.
The Benefit: It provides immediate certainty. Once the transfer is done, the recipient has their own independent pension that they can manage, contribute to, and draw from according to their own retirement plans.
The Reality: The "pension credit" (the amount received) does not have to stay with the original provider. It can usually be moved to a scheme of the recipient’s choice.
2. Pension Offsetting
In this scenario, the value of the pension is "offset" against another asset, typically the family home. For example, the wife might keep a larger share of the equity in the house in exchange for the husband keeping his pension intact.
The Benefit: It allows one person to stay in the family home, which is often a priority when children are involved. It avoids the administrative complexity of splitting a pension.
The Pitfall: This is where many people get caught out. A pound in a bank account is not the same as a pound in a pension. Pensions are subject to tax when they are drawn, and they are illiquid. If you trade £100,000 of house equity for £100,000 of pension value, you might be making a very poor deal. Expert valuation is essential here.
3. Pension Attachment (formerly Earmarking)
This is much less common today. A Pension Attachment Order directs the pension provider to pay a portion of the pension (and/or the tax-free lump sum) to the former spouse when the pension holder starts to draw it.
The Pitfall: It does not provide a clean break. The recipient is dependent on the former spouse’s decisions; if the pension holder decides to delay retirement or dies before drawing the pension, the recipient may get nothing. Furthermore, the payments stop if the recipient remarries.
The "CEV" Trap: Not All Pensions Are Created Equal
One of the most dangerous mistakes a person can make in a divorce is taking the "Cash Equivalent Value" (CEV) at face value.
There is a fundamental difference between Defined Contribution pensions (pots of money like a SIPP or a standard workplace pension) and Defined Benefit pensions (final salary schemes common in the public sector).
A Defined Benefit scheme often has a CEV that significantly underestimates the true cost of "buying" that same level of guaranteed, inflation-linked income on the open market. If you are divorcing someone with a final salary pension, the stated value on their annual statement might only be the tip of the iceberg.
To ensure fairness, we often recommend the instruction of a Pension On Divorce Expert (PODE). A PODE is an actuary or specialist financial neutral who can look past the surface numbers and calculate what percentage split is actually required to produce equal incomes in retirement.
The 2027 Inheritance Tax Cliff: A New Consideration
As we highlighted in our recent review of the Autumn Budget, the tax treatment of pensions is set for a major overhaul. From April 2027, unused pension pots will be included in a person’s estate for Inheritance Tax (IHT) purposes.
For decades, pensions were seen as a tax-efficient way to pass wealth to the next generation. This made them highly attractive assets to hold onto in a divorce settlement. However, with a potential 40% tax hit looming for larger estates, the "long-term value" of a pension has changed.
When negotiating a settlement today, we must consider whether a Pension Sharing Order is still the most efficient route, or if the future tax liability makes other assets more attractive. If you are agreeing to a settlement now that will conclude near or after the 2027 threshold, these tax implications must be written into the heart of the agreement.
What About the State Pension?
The Basic State Pension cannot be shared in a divorce. However, if you reached State Pension age before 6 April 2016, you may be able to use your former spouse’s National Insurance contribution record to increase your own basic State Pension, provided you do not remarry before you retire.
For those under the New State Pension system, the rules are different and generally less flexible, but it is still possible to share a "Protected Payment" (an extra amount of State Pension) if the court makes a specific order. This is a technical area that requires a specific "State Pension forecast for divorce" (form BR19).
The Importance of the Pension Sharing Order
A common misconception is that a "Decree Absolute" (or Final Order) ends all financial ties. It does not.
If you agree to split a pension, that agreement must be formalised in a Pension Sharing Order, which must be approved by the court as part of a wider Consent Order. Without this formal document, the pension provider has no legal authority to move the funds. We have seen cases where couples "agreed" to split a pension years ago but never got a court order, only to find that when the time came to retire, the law did not recognise their informal arrangement.
How D&A Solicitors Can Help
Pensions are complex, and the law surrounding them is constantly evolving. At D&A Solicitors, we don't expect you to be a pension expert—that is our job.
Our approach is built on three pillars:
Thorough Disclosure: We ensure that every pension asset—including old workplace schemes from years ago—is put on the table.
Expert Collaboration: We work with trusted PODEs and financial advisors to ensure the valuations we are working with are accurate and reflect the true cost of future income.
Future-Proofing: We consider the latest tax changes, such as the 2027 IHT rules, to ensure your settlement doesn't leave you with a surprise tax bill down the road.
Divorce is the end of a partnership, but it shouldn't be the end of your financial security. If you are concerned about how your retirement savings will be affected by a separation, reach out to our team in Birmingham. We provide the clarity and expertise needed to ensure that your future remains on solid ground.
Contact us today
Tel: 0121 523 3601
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