David Downie: The crucial role of advisers (and cashflow models) in 'no fault' divorces

As a new Act is expected to spark an increase in divorces, the need for actuarial support and straightforward financial advice rises too, explains David Downie

Is this the end of the blame game? In April next year, the Divorce, Dissolution and Separation Act 2020 – designed to allow married couples in England and Wales to issue divorce proceedings without assigning blame – comes into force.

Under the current law, one spouse must effectively accuse the other of being responsible for the ‘irretrievable breakdown’ of the marriage, perhaps due to adultery or desertion.

However, the new Act, dubbed the ‘no-fault divorce’ Act, means a married person can wake one morning, ask their spouse for a divorce, and proceedings can begin.

Divorces will be going through the courts faster, and therefore the fair distribution of pension benefits on divorce takes on new significance.

The ‘grey’ divorce

You probably saw the news: after almost three decades of marriage, Bill and Melinda Gates announced in May their plans to separate. A judge approved their split in August.

On the one hand, because of the money involved, their story was unusual, but on the other, it wasn’t – the demographic trend for older couples to file for divorce has been observable for a while.

A study by US ‘fact tank’ Pew Research Centre found that, between 1990 and 2015, the over-50 age bracket had seen a doubling of divorce rates, while the over-65s had seen a tripling.

When older couples divorce, the family home is typically thought of as the main asset, but often the couple’s pension assets trump it as a value. In my experience, it isn’t uncommon for many clients – taking the example of an average bank branch manager with 25 years’ service – to rack up a final salary pension with a transfer value of £800,000.

As divorce rates continue to climb, particularly among older couples, there are going to be many cases where significant pension assets will need to be independently assessed.

Reaching a fair split

At this stage, actuarial support is crucial. An actuary will assist the couple – and the courts – by outlining options on how pension assets can be split fairly. They will not pick sides but suggest how to achieve a fair outcome.

Firstly, they will allow for any age difference between spouses, which often means the fair distribution of benefits is rarely 50:50. This is not straightforward even for simpler schemes like money purchase or defined contribution. An age gap as narrow as three years can distort a 50:50 calculation, so an actuary will outline the options that provide an equal income.

Secondly, they provide clarity where a government-sponsored final salary scheme – such as the Teachers’ Pension Scheme – is involved. Typically, the transfer values of these schemes are poor and insufficient for replicating the benefit for a spouse. Therefore, an actuary will assess the benefit on offer and seek to remove any distortion between transfer values, considering any other schemes the couple are in.

For example, both parties could have the same annual pension offer on the table – say £5,000 – but the schemes’ values could be quite different. This is because transfer values are dictated by assumptions agreed by a scheme’s trustees. An actuary will strip everything back and value both elements using the same assumptions. Apples, with apples.

The crucial role of financial advisers

A financial adviser may be the second person (perhaps the first) to hear about divorce proceedings.

Should they come across any sort of complexity in the pension assets, they should seek independent actuarial advice.

Once the actuary’s report is ready, an adviser is best placed to walk their clients through the options. A report may include two or three possibilities, and an adviser can run through each scenario using simple cashflow modelling.

There’s little sense in telling one party they will receive £500,000 and the other party £500,000, because they may not be the same age, and they may have different income needs. Clients will not know if £500,000 is enough to meet their income requirements, but may well know, via cashflow modelling, if £3,000 a month for life will. That will mean something to them.

Sometimes one option for clients is to become a member of an ex-spouse’s scheme. This will give the new member a pension entitlement from the day they join. While it isn’t difficult to calculate the cashflow impact in this scenario, it’s still important that a professional explain it.

Once pension complexity has been identified, and an actuarial report completed, advisers can help their clients understand the financial implications of their options.

In summary…

  • The Divorce, Dissolution and Separation Act 2020, which comes into force in England and Wales on 6 April 2022, could trigger more – and faster – divorces.
  • The demographic trend of older couples divorcing is real and observed.
  • The likelihood of valuable pension assets and degrees of complexity being issues to address may be greater as a result.
  • Where any pension complexity is identified, actuarial support is needed to provide clear options for clients and courts (and advisers).
  • Financial advisers are uniquely placed to walk their clients through the options and, where there is a lump sum concerned, to use cashflow modelling to translate it into numbers clients will understand.

David Downie is group chief actuary at Embark Group