Easy as CEV? How to treat pensions upon divorce: W v H (divorce: financial remedies)  EWFC B10
28th May 2020
by Henrietta Boyle, Pupil, One Hare Court
In this judgment, HHJ Edward Hess discussed three issues relating to the treatment of pensions upon divorce and considered the opinions of The Pension Advisory Group set out in their report, “A Guide to the Treatment of Pensions on Divorce”, published in July 2019.
W (“the wife”, 50) and H (“the husband”, 48) had met in 1998 while they were both working at the same financial services company (“X”). They cohabited from 1999 and married in 2005. They separated in February 2016, when the husband told the wife that he had commenced a relationship with a business associate of his who was in her early thirties. There were three children of the marriage: A (18), B (16) and C (10). They remained living in the family home (“FMH”) with the wife, and had little or no contact with the husband.
HHJ Edward Hess gave judgment after the final hearing of the wife’s application for a financial remedy. He discussed three issues that arose in the case regarding the husband’s defined benefit pension scheme, which had a CE of £2,155,475. The issues were:
1. Whether it was right for the court, in dividing pensions with a view to promoting equality, to target capital equality (i.e. equal CE or other definitions of capital value) or to target the promotion of equal incomes;
2. Whether it was right for the court, in dividing pensions with a view to promoting equality, to exclude a portion of the member spouse’s pension if it was earned prior to the marriage or seamless pre-marital cohabitation; and
3. The extent to which the court should disaggregate the pensions in a case and promote a discrete and equal division of the pensions, as opposed to attempting to execute an offset against other assets.
In dealing with the issues, HHJ Hess considered the opinions of The Pension Advisory Group (PAG, of which he is Co-Chair) set out in A Guide to the Treatment of Pensions on Divorce: The Pension Advisory Group Report, published in July 2019. Acknowledging his interest in PAG, he said that the report ‘should, in my view, be treated as being prima facie persuasive in the areas it has analysed, although of course susceptible to judicial oversight and criticism’ (see paragraph 59).
Should the court target capital equality or the promotion of equal incomes?
HHJ Hess said there was ‘no ‘one size fits all’ answer to this question’. He identified that ‘[t]here are undoubtedly scenarios where the fair solution is probably to divide pensions by CE value’, but recognised that there are also scenarios ‘where a simple division of CEs may well not represent a fair solution’ (see paragraphs 60(i) and (ii)).
The following examples were given of cases where the fair solution would be to divide pensions by CE value (see paragraph 60(i)):
i. Where the CEs are relatively small either in themselves or as a portion of the assets overall.
ii. Where the parties are relatively young and any projections about the future income-producing qualities of the pensions are likely to be speculative or unreliable.
iii. Where all the pensions are simple defined contribution funds so that the CE values can be regarded as reasonably reliable and simple predictors of future income streams.
iv. Where the sole pension involved is a non-uniformed public sector defined benefit scheme offering internal transfers only.
The following examples were given of cases where a simple division of CE value would not be a fair solution (see paragraph 60(ii)):
i. Where the pensions are medium or large, both in themselves and as a portion of the assets overall, but needs issues still arise, particularly where:
a. One or more of the pensions involved is a defined benefit scheme, and income from within the scheme per £ of CE is likely to be higher than annuity income outside the scheme per £ of CE on an external transfer.
b. The parties are no longer young and retirement issues are on the horizon.
HHJ Hess quoted the PAG report, which says that in a needs-based case, particularly where there is a significant defined benefit pension involved, where a fair outcome is sought ‘the appropriate analysis will often be to divide the pensions separately from the other assets, based on an equalisation of incomes approach, such approach often requiring expert evidence from a PODE [Pensions on Divorce Expert]’ (see paragraph 60(iii)).
He also quoted the Family Justice Council’s report Guidance on Financial Needs on Divorce (2018 edition), which says ‘[i]n bigger money cases, where needs are comfortably met, the courts are now likely to be less interested in drawing a distinction between pension and non-pension assets than hitherto…In small to medium money cases, however, where needs are very much an issue, a more careful examination of the income producing qualities of a pension may well be required in the context of assessing how a particular order can meet need’ (see paragraph 60(iv)).
Should the court exclude a portion of the member spouse’s pension if it was earned prior to the marriage?
HHJ Hess considered the ‘straight line’ deduction approach to pensions. In this method, a straight line deduction is made from the CE of a pension fund by reference to a fraction, where the numerator is the number of years of the marriage (including seamless pre-marital cohabitation) and the denominator is the number of years over which the pension fund in question was accrued. The court then includes in its deliberations only the reduced amount of the CE.
He observed that ‘this approach carries with it significant risks of unfairness’ (see paragraph 61(i)). Where cases involve defined benefit pension schemes, HHJ Hess commented that the straight line methodology ‘conceals an unfairness in that the value of a defined benefit pension scheme based on final salary does not accrue on a straight line basis…The pension will accrue much more value in its later years when the member spouse has reached the high salary level and this is likely to be…firmly during the marriage’ (see paragraph 61(vii)).
He expressed surprise that the judgment of Thorpe J (as he then was) in H v H  2 FLR 335 is now thought to be authoritative on the issue of straight line deductions, given that it ‘was a pre-pension sharing case, there was no reference to CEs in the judgment and [Thorpe J’s] emphasis was on the comparison between pension rights earned during the cohabitation and future pension rights’, and because White v White  UKHL 54 had not been decided and the use of CEs was not widespread (see paragraph 61(ii)). Indeed, HHJ Hess pointed out that later, in Harris v Harris  1 FCR 68, Thorpe LJ said ‘I do not myself find the argument on proportionality to the pension earned during the marriage to be an attractive one’.
Ultimately, HHJ Hess said that ‘[i]n one sense the exclusion of the pre-marital portion of the pension is no more than, in modern parlance, the identification of non-matrimonial property’. He commented that ‘[w]here the pension was wholly accrued prior to the marriage then it is easy to identify it as non-matrimonial property’, and noted that ‘pension funds are rarely subject to the ‘mingling’ which often occurs in relation to cash assets’ (see paragraph 61(iii)).
Adopting the established principles in relation to non-matrimonial property, HHJ Hess concluded that ‘[i]n a sharing case the exclusion of the pre-marital portion of a pension might well be a legitimate exercise in principle, although, as identified in M v M  EWFC B63, the court might retain an element of discretion as to the level of sharing’. He contrasted this with a needs case, where ‘the approach needs to be treated with more caution. Where the pensions concerned represent the sole or main mechanism for meeting the post-retirement income needs of both parties, and where the income produced by the pension funds after division falls short of producing a surplus over needs, then it is difficult to see that excluding any portion of the pension has justification’ (see paragraph 61(iv)). He drew attention to the fact that recent changes to the Lifetime Allowance (currently £1,055,000) mean that ‘it is quite unlikely that pension funds will themselves…take the case outside the category of a needs case’ (see paragraph 61(vi)).
He concluded that ‘where an apportionment is to be made, the straight line methodology of apportionment may well not be fair and some caution needs to be exercised before using it if other fairer methodologies are available’. Other methodologies he suggested include ‘inviting the PODE to make a notional calculation of the current CE on the basis that the member spouse’s earnings rose only with inflation in the post-marriage period’ (see paragraph 61(vii)).
Should the court disaggregate pensions and promote a discrete and equal division of pensions, as opposed to attempting to execute an offset against other assets?
HHJ Hess noted the orthodox view, encouraged by Thorpe LJ in Martin-Dye v Martin-Dye  2 FLR 901, that pensions should be dealt with separately and discretely from other capital assets. However, he pointed that that ‘many litigants choose to blur the difference between the categories and engage, to a greater or lesser extent, in an offsetting exercise’. He said it needs to be borne in mind that ‘mixing categories of assets runs the risk of unfairness in that valuation issues become very difficult and, absent agreement, it may be unfair anyway to burden one party with non-realisable assets while the other party has access to realisable assets’ (see paragraph 62(ii)).
The other features of the case and the resulting treatment of the husband’s defined benefit pension
A summary of the other features of the case is as follows:
i. The FMH had net equity of £241,782 and was jointly owned. The husband agreed that it should not be sold until November 2024, when the parties’ interest only mortgage was due to expire. HHJ Hess rejected the wife’s argument that she should retain more of the equity because she had made a larger cash contribution to the parties’ first family home, and said each party would receive 50% of the net proceeds of sale.
ii. The most valuable asset by far was the husband’s defined benefit pension. In addition to this and the FMH, both parties had a very small amount of cash in bank accounts, and significant debts. The wife had two pensions with a total CE of £152,737, while H had a second (defined contribution) pension with a CE of £58,653.
iii. Until separation, the wife had not worked since having A. Her role in the family was as the homemaker. In March 2019 she had started a dog-related business from the FMH, and she estimated that by 2022 she could earn £14,200 pag (or £1,100 pcm net). HHJ Hess accepted that this business was ‘a reasonable maximisation of her income at the moment, and for as long as she remains in the family home it is reasonable to assess her on this basis’ (see paragraph 27). However, he said there would come a time when it might be reasonable for her to be assessed on the basis that she could earn more in a PAYE job, in the region of £18,000 pag or perhaps a little more.
iv. HHJ Hess noted that W would also receive income by way of spousal periodical payments, and also child periodical payments and child benefit until C left school in Summer 2027.
v. H had worked for X for all his working life and had an earning capacity of £9,631 pcm. There was no reason why he should not continue earning at this level for the foreseeable future, probably until he was 60, and possibly beyond that until his state pension age of 67.
vi. Both parties would need a suitable home, although the husband would almost certainly have to rent accommodation until the FMH was sold in November 2024.
vii. Given the husband’s income, the wife’s income demand for a global amount of £3,750 pcm was certainly affordable to the husband and the quantum of maintenance sought by the wife was not unreasonable in all the circumstances.
In relation to pensions, HHJ Hess decided that ‘I should divide the pensions in this case with a view to making pension sharing orders which have the effect of providing for the parties equal incomes at a specified time in the future’ (see paragraph 63(i)). This was because of the ages of the parties, the size and largely defined benefit nature of the pension funds, and the relative paucity of non-pension assets (see paragraph 60(v)).
He adopted the PODE’s recommendation that the appropriate equalisation age in this case was 60. Both parties had worked on the assumption that the wife would be able to draw a tax-free lump sum when she turned 55 in November 2024, which would enable her to rehouse when the FMH was sold. On this basis, the scenario put forward by the PODE whereby a straight line discount was applied to the husband’s defined benefit pension would not provide the wife with enough pension income to enable her to meet her ongoing income needs into retirement.
HHJ Hess therefore identified that ‘we are firmly in a ‘needs case’ category here’, in which case ‘it would be wrong for me to follow the logic of the straight line discount advocated by the husband’. He concluded that ‘the proper and fair approach is for me to seek to equalise incomes on an equal basis taking into account all the pensions’ (see paragraph 63(vii)). W had asked for 100% of the net equity in the FMH in return for H retaining a larger portion of his defined benefit pension, but HHJ Hess rejected this proposed offset.
Other points of interest
In addition to his guidance on the treatment of pensions, HHJ Hess made several other points of interest:
a. Global orders HHJ Hess said that ‘[t]he existence of a global order carries with it the complication of knowing how to proceed in the future if, for example, circumstances change such as the spousal element is to be deleted because…of a remarriage’. He concluded that ‘if a disaggregated order can be made fairly then that is often the better approach’ (see paragraph 70(i)).
b. Child maintenance orders and the move from secondary to tertiary education HHJ Hess quoted from the Dictionary of Financial Remedies (2020 edition) which says (at page 12) that the standard cessation date for a child periodical payments order is the date when the relevant child turns 18 or ceases full time education (ordinarily defined as tertiary education up to a first degree). It says it is not uncommon to extend orders to cover a gap year, either before or after university, or a Masters degree, but notes that a parent is entitled to be protected against the child’s prolonged or indefinite deferral of attendance at university and refers to Re N  1 FLR 1442. When a child moves to university, it also comments that it is not uncommon to redirect all or some of the child periodical payments to the child themselves, but that a roofing allowance of one third of the total is not uncommonly paid to the parent with care.
c. Pensions and the duration of spousal maintenance orders HHJ Hess said that the termination of a spousal maintenance order needs to take into account pension distribution, because if that has been executed to achieve equality, then allowing an ongoing spousal order beyond the retirement date runs the risk of upsetting the fairness of the scheme of capital distribution.
d. Costs W owed her solicitors £26,041, and invited HHJ Hess to make an instalment lump sum order of £1000 pcm for 26 months to pay this off. HHJ Hess considered this was a ‘back door way of applying for a costs order’. He did not think it would be fair to ‘make an order which caused the husband to have to pay this bill directly’, bearing in mind the general ‘no order for costs’ rule under FPR 28.3(5), the fact that there were no conduct issues, and the fact that the husband had decided not to employ a legal team for the final hearing because he did not think he could afford it (see paragraph 41). However, he recognised that the debt existed and was a problem for the wife which he could not ignore. Rather than making a specific order, he ignored the wife’s receipt of tax credits (which she was likely to receive as a windfall for a short period of time), and in dealing with pensions bore in mind that the wife may need to meet some of her debt from her tax free lump sum.
As Co-Chair of PAG (among other appointments), HHJ Hess’ comments on pensions should be treated as authoritative. This judgment makes clear that the straight line approach to discounting pensions, and offsetting pensions against other assets, risk unfairness, and that they should be undertaken with caution. Furthermore, although HHJ Hess said there was no ‘one size fits all’ solution to whether the court should target capital equality or equality of income, this judgment makes explicit that there are certain categories of case where the fair solution is obvious. Indeed, for the needs-based cases most commonly encountered by practitioners, this judgment, PAG, and the Family Justice Council have all encouraged that the income-yield of a pension should be looked at very carefully and should not be brushed over for the sake of focusing on the CE and capital outcome.