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WS v WS: Pensions experts' review

WS v WS: Pensions experts' review

The case for pension experts

In the recent case of WS v WS [2015] EWHC 3941 (Fam), a judgment was made to offset the value of a defined benefit pension scheme using the Duxbury formula. The decision was made without reference to an expert pension report, the husband's request for one having been refused. How might the input of a pension expert have influenced the decision-making process in this case?

Expert pension and divorce knowledge

Understanding the reasons for offsetting rather than pension sharing should play a significant part in evaluating a pension offset amount. In the case of WS v WS the reason for offsetting was due to an understanding that pension sharing would take the husband well over the Lifetime Allowance with severe taxation consequences.

In this case, both the husband's defined contribution plan (valued at £970,696) and the wife's defined benefit pension (valued at £3,064,154) had both been crystallised; tax-free lump sums had already been paid. A pension expert would have highlighted to the court that the reason for avoiding a sharing order appears, on the facts disclosed in the judgment, to be specious. As both pensions have already been tested against the Lifetime Allowance by HMRC, the husband would receive an uplift in his Lifetime Allowance equal to the value of the pension credit received.

Consequently, even if no actuarial adjustments were made to balance the difference between the two different types of pension and they proceeded to equalise on cash equivalents, the husband would have an extra £1,046,729 in his pension instead of the £425,000 in his bank account awarded by the judge using Duxbury.

The chart below assumes the husband draws £25,000 per year net of 40% income tax from investments growing with a 2.5% real return, a rate chosen as a reasonable growth assumption. The offset lump sum is invested in an identical portfolio to the pension without the income tax and capital gains tax protection available in the pension fund. While the £425,000 pot runs out at age 80, the pension pot is still going at age 100. When the offset sum is spent, his pension would still be worth more than £1,000,000.

Pick a card, any card

In the absence of an impartial assessment, the judge was presented with a wide spectrum of options from which he concluded 'there is no obviously right figure or correct calculation'. An alternative view might be that it is not that the answers are wide and varied, but that each variant is an answer to a different question. If the question can be clearly defined, so too will be the answer.

In many cases, the reason for choosing offsetting is known. For example, it might be that the pension is highly valued but the pension member does not want to share, or, conversely, that the immediate value of cash is more highly prized. If both desire a secure income for life and it is being denied to one, the offset question might focus on matching the guaranteed income quality of the pension and require a high offset. If cash-in-hand is being fought for, the delayed enjoyment by the one holding the pension might be the focus of the question and result in a low offset figure.

In the case of WS v WS the flawed motivation for offsetting is to avoid the 'severe taxation consequences' of a 55% Lifetime Allowance tax charge deducted from the husband's pension credit. Even if a Lifetime Allowance charge was applied and the husband inadvisably immediately withdrew all his money from the tax shelter of his pension, the tax rate of 55% on an award of £1,046,729 would leave him with £471,000. It is hoped that the reader has already started to consider that the Duxbury calculation of £425,000 was a more severe consequence.

As the case here appears to be built on a false premise, the judge was in an uneviable position. Both are drawing pension benefits, and one imagines that both value them. At 61, the husband is likely to jealously regard the wife's secure, inflation-proofed, sleep-at-night pension. While he has significant other assets, even ultra-wealthy clients value having cash and guaranteed investments as part of their portfolio. A guaranteed return from cash, gilts or a defined benefit pension gives the holder more freedom to speculate with their other assets. If the offset question can be seen as generating answers at two polar positions, in the absence of a cogent reason for the offset one might reasonably expect a decision that meets somewhere between the two. A Duxbury calculation, however, is - in the opinion of many pension experts - the iciest tip of one of the poles.

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A pension is backed by real assets

As Lewis Marks QC states in 'An Alternative View of Duxbury: A Reply' [2010] Fam Law 614, a Duxbury calculation: '... is not, and never has been, intended to provide guaranteed spending power, let alone ... an income which is guaranteed.' If one party retains a pension asset that provides such a guaranteed income, Duxbury is, by this definition,  an inappropriate formula to use to offset it.

In the same article, it is stated that: '... the Duxbury fund is intended to represent the current capital value ... of the right to the periodical payment stream it replaces ... [which] is not guaranteed and can be terminated.' A pension fund, however, is not an uncertain future income stream. It is an investment with real assets that has been accumulated as a result of diverting previous remuneration. Both parties suffered from less disposable income during the period of building up the pension pot in the same way that they did with any other savings.

Optimistic growth assumptions requiring aggressive investment returns may be acceptable when the periodical payments being replaced are subject to their own commensurate risks. However, the holder of a pension, particularly the defined benefit pension in payment owned by the wife, does not take the same risks. Her guaranteed lifetime income is underpinned by cautious, low-risk assets in the scheme with the sponsoring employer paying all costs and funding any investment shortfall. The real return required by Duxbury is 3.75% per year, assuming inflation at 3%, no charges and after tax. At the time of writing, 30 year gilts yield 2.35% per year before tax and charges, and assuming inflation at Duxbury's 3% represents a real return of minus 0.65% per year. While gilts may be expensive and poor value, the yields are the grim reality of the world that the Duxbury offset recipient seeking a lifetime income has to survive in.

In an uncertain world, why should one party be forced to settle for a return pinned on  hope when the other already owns the assets fully underpinned at the current market price? A pension expert could explain that, far from the cash equivalent being 'illusory' and 'artificial' as described in this case, the value represents the market cost of buying the stated income. The value is as illusory and artificial as the often-argued inflated prices of the London housing market, but surely no-one would argue equality was met if one party retains a London property and the other has cash that cannot buy a similar home? If the cash holder wants a London property they have to pay the London house price, and so too must a pension income seeker pay the market price whether they think the assets are expensive or not.

A sum based on Duxbury will provide a matching income if the ambitious returns are realised and you live to normal life expectancy. Life expectancy is defined as the average period that a person may expect to live. This means that, if you spend your money in such a fashion that it runs out at your life expectancy, there is  an approximately 50% chance that you will live to regret it.

If both the pension member and the recipient of the Duxbury calculated offset die before the normal life expectancy, neither are financial winners; they are both dead having not made full use of their financial assets. However, the pension holder would have enjoyed a better standard of living because the holder of the offset cash would likely have managed their money to last their potential unknown lifetime which, for the sake of prudence, they might assume went into their 90s. And, for the 50% who live beyond normal life expectancy, the clear winner is the pension holder.

Given the theoretical choice of either being the person retaining the pension or the person accepting the Duxbury offset, almost ever pension expert would take the pension. This should tell its own story.

Pension expertise

The value of pensions in the hands of the holder has become more complex to evaluate since the introduction of Pension Freedoms. Not all pensions are unshackled (such as defined benefit pensions in payment, annuities and all public sector pensions), and the personal circumstances of the individual determine how the impact of income tax, capital gains tax, inheritance tax and Lifetime Allowance tax impact on the pension's relative value.

In WS v WS a pension expert would have corrected the apparent Lifetime Allowance misconception and provided balanced offset calculations that more closely match the true value of the pension assets retained by the wife.

In short, the case for the involvement of pension experts in divorce cases has never been stronger.

The following pension experts agree that the opinions expressed in this article broadly reflect their own views:

Stephen Bridges (Bridges UK Actuarial Services Ltd);
Paul Cobley (Oak Barn Financial Planning);
Ian Conlon (IWC Actuarial Limited);
Peter Crowley (Windsor Actuarial Consultants);
Dani Glover and Julian Whight (Smith & Williamson Financial Services);
Miles Hendy (Fraser Heath Financial Management Ltd);
George Mathieson (Mathieson Consulting Ltd);
Peter Moore (Bradshaw, Dixon and Moore [BDM]);
Mark Penston (Bluesky Chartered Financial Planners);
Kate Routledge and Jim Sylvester (Collins Actuaries);
Clive Weir (Albert Goodman);
Geoffrey Wilson (Excalibur Actuarial); and
Paul Windle (Actuaries for Lawyers)
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