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  Approaches and Options   "The provider CETV significantly undervalues the pension value"

Based on the cash equivalent transfer value a pension on divorce can be valued at significantly less than it's true value. This is partly due to the CETV being calculated for a pension member that is leaving service whereas on divorce the spouse is still a member and therefore an adjusted CETV is required for a fair value.
  Introduction   CETV Method   Valuation reports
  Legislation   Other methods   Pension audit results

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Introduction
The standard cash equivalent value from the provider can significantly undervalue the retirement benefits but there are valuation options that will reflect the circumstances and specific needs of the parties. Legislation prescribes methods for calculating the value of retirement benefits in the form of the cash equivalent transfer value (CETV). When applying a valuation method to members pension rights within pension arrangements, there will be factors to consider beyond the legislation currently in place.

The CETV Method was chosen primarily because it is a method that already exists for the calculation of benefits for early leavers and therefore is a method that can be easily obtained from the arrangement providers whether this is via employer pensions or private pensions. In certain circumstances the CETV is the correct method for arriving at a fair valuation of retirement benefits, however for a final salary pension or public service scheme the assumption that the member terminates membership of the pension scheme by way of leaving service, will distort the valuation of benefits that could be apportioned as the spouses lost rights on divorce or nullity of marriage.

It will be necessary for those divorce cases where the CETV from the scheme administrator is not appropriate to consider other methods of valuing retirement benefits to produce a suitably adjusted CETV. This should be done irrespective of whether the division of the matrimonial assets will use offsetting as a settlement, earmarking order or pension sharing order.



Legislation
Although the court have been directed to have regard to the retirement benefits of a couple on divorce as set out in the Matrimonial Causes Act 1973 (MCA 73) and where offsetting pensions against other matrimonial assets has been preferred, there has been little specific guidance on the valuation of the many different pension arrangements from occupational pension schemes such as final salary pensions to personal pensions.

Within legislation introduced by section 30 of the Welfare Reform and Pensions Act 1999 (WRPA 99) and effective from 1 December 2000, there are provisions that require the use of the cash equivalent transfer value (CETV) as the prescribed method of valuation. This is outlined in subordinate legislation such as the Pensions on Divorce etc (Provision of Information) Regulations 2000, the Divorce etc (Pensions) Regulations 2000 or the Pension Sharing (Valuation) Regulations 2000.

The CETV assumes the scheme member will leave service on the valuation date and will not include other spouses pension rights. The CETV is a well established method and applies to the valuation of a members pension rights for early leavers from an occupational pension scheme or personal pension where the scheme member wishes to transfer accrued rights to another pension arrangement. The calculation for the CETV in the context of early leavers is applied under section 97 of the Pension Schemes Act 1993 (PSA 93) and on divorce, the calculation of the CETV of retirement benefits during ancillary relief proceedings essentially reflects these principles.

In circumstances where the CETV does not value the retirement benefits fairly the Divorce etc (Pensions) Regulations 1996, although now repealed and replaced by the Divorce etc (Pensions) Regulations 2000, offer some useful guidance in paragraphs 14 to 16 as follows:

Paragraph 14 states that insofar as pension rights accrued up to the time when the court considers financial provision on divorce are concerned, the divorcing parties will not be permitted to use any method of valuation other than the prescribed method. It would, however, be open to them to dispute whether the prescribed method has been correctly applied.
   
Paragraph 15 states that the Divorce etc (Pensions) Regulations 1996 will not prevent the parties providing further information as to the expectation of the pension, and will not prevent the court from taking account of that information in circumstances where it deems the cash valuation provides an inappropriate or inadequate indication.
   
Paragraph 16 states that the prescribed method cannot be used for discretionary benefits not including in the CETV or pensions administrated outside England and Wales. Regulations cannot, therefore, bar other methods of valuing such pension benefits.


CETV Method
The court will initially require the cash equivalent transfer value of the members pension rights. On receiving the order from the court the member of the pension arrangement must request the valuation from the provider within 7 days. The pension provider has six weeks to return the valuation of the members pension rights.

The CETV produced by the scheme administrator as shown in the step-by-step guide represents the pension fund value of the scheme members retirement benefits at the time of the valuation, assuming the member is leaving pensionable service at that time. The CETV is an appropriate valuation method for a money purchase scheme issued after 6 April 2001 such as stakeholder pensions or a personal pension where a single charge is made to the pension fund value and no penalties if a pension transfer is applied.

However for more complex arrangements within an occupational pension scheme such as a final salary pension, the CETV will not include death in service benefits, spouses pension rights, discretionary benefits issued by the scheme trustees and future expectations of the scheme member. The valuation method should also consider the spouses lost rights, not just the members pension rights on leaving service as reflected in the cash equivalent transfer value from the provider, and this approach will result in a fully valued CETV.


Other options
For a couple on divorce and during ancillary relief proceedings that involve pension arrangements, a pension audit of the members pension rights is important to establish a fair value for retirement benefits. When viewed with other matrimonial property and appreciating that pensions are not necessarily realisable assets, it will be possible to decide the division of assets between the parties by using offsetting, earmarking or pension sharing. Although the cash equivalent transfer value is the prescribed method in legislation and would be used as the basis of any valuation, an adjusted CETV will consider additional valuation options if permitted by the court or agreed by the parties.

In particular for the spouses lost rights in a final salary pension within an employers pension scheme, a pension audit would have to consider alternative valuation methods such as the past service reserve. This takes into account the fact that a final salary pension will maintain reserves in anticipation of increases in pensionable earnings due to career progression or inflation linked to the retail price index (RPI). The audit could also consider the fund value approach that is an actuarial calculation of benefits to the member if the scheme was wound up. A surplus may mean a pension fund value for the scheme member greater than the CETV whereas an underfunded scheme could result in a lower value.

The valuation method used may need to be adjusted to reflect the approach in dividing the assets, such as offsetting, earmarking or pension sharing. For example, offsetting retirement benefits would exchange usable assets for unrealisable retirement benefits where pension income is taxable and pension sharing will result in a clean break financially today whereas earmarking will require a projection of benefits to a retirement age. In all circumstances the CETV is used as the basis of valuation and the result will always be an adjusted CETV reflecting the circumstances and specific needs of the parties.


Valuation reports
During ancillary relief proceedings where the pension arrangements form a significant part of the matrimonial assets and are complex in nature such as with a defined benefit final salary pension, it will be necessary to conduct a pension audit of the members pension rights. This is particularly the case where the cash equivalent transfer value, being based on the assumption that the member leaves service on the day of valuation, does not satisfactorily determine a fair value of the retirement benefits, as would be the case with a final salary pension.

The pension audit will determine a CETV adjusted as appropriate, reflecting the circumstances and needs of both parties. The valuation report explains what would be a fair value of the retirement benefits, specifically with regard to the spouses lost rights as a result of divorce or nullity of marriage or judicial separation. These rights are different from the members pension rights as illustrated in the CETV from the provider. The report will show the valuation options applicable to the pension arrangement such as past service reserve or fund value and the valuation if applied to offsetting, earmarking or pension sharing.

This may include any death in service benefits, widows pension, any future increases in benefits to the member and the likely increase in earnings of the member up to retirement. Also there will be consideration of the tax implications of pensions as opposed to a cash settlement on divorce and a consideration of any distortion of the members pension rights due to the current funding of the scheme. In summary, some of the factors to consider will be:

Special features of unfunded public service pension schemes;
State pensions;
Ill health and retirement benefits;
Death in service benefits;
Discretionary increases to pensions in payment;
Solvency of pension schemes;
Differences in age and life expectancy;
Improving mortality.

The impact of any percentage against the members pension rights due to an earmarking order or pension sharing order may, if required, be reflected in the report by a calculation of the members reduced benefits or negative deferred pension at the normal pension age, so the final position of both parties can be clearly seen.


Pension audit results
The following table summarises the findings from recent cases of UK divorce and the value added by the the pension audit.

Pension audit results
  Case details
Case A Case B Case C
  Audit Rating
A A A
  Married for (years)
25
34
22
  In main scheme (years)
23
35
40
  Income of member
£18,100
£30,100
£33,300
  Initial valuation
£165,600
£292,600
£399,700
  Adjusted value
£219,000
£396,300
£557,000
  Value added by audit
£53,400
£103,700
£157,300

It is often the case that once the parties realise the fair value of the retirement benefits rather than just the CETV from the scheme administrator, more negotiation will be required through their solicitors to reach a settlement. The solicitor for the former spouse can make an offer to the other party as the step-by-step guide shows and include the adjusted value.

Any negotiations may require further pension calculations from the pensions consultant to help with the process or if sufficient time has elapsed, up to date calculations will need to be done again. This is why it is worthwhile for the parties to pay a fixed fee rather than an initial fee plus for expert evidence. A pensions consultant with a recognised qualification such as G60 Pensions or equivalent should undertake the pension audit. The parties should have sufficient confidence that the pensions expert is knowledgeable in the area of pensions on divorce.

Where there is an internal or external transfer for a money purchase scheme, the spouse may need further advice if nearing retirement and requires an income the pension fund to buy an annuity. Here there is an option to use an open market option to search for the highest pension annuity, adding all the features necessary such as escalation, frequency of payment or a new survivors income. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised pension annuities quote offering guaranteed rates.

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