Earmarking was introduced for petitions for divorce filed on/after 1st July 1996.
Under this method the court allocates a specified portion of the scheme member’s lump sum, death benefits and income entitlement to the ex spouse. This is evidenced by an order from the court to the trustees. The ex spouse will then receive the relevant portion of pension benefits when the scheme member receives benefits.
It does not give ownership rights to the pension as would be the case with a pension sharing order. It is simply a means whereby part of the benefit can be received by the ex spouse. The order may come into force immediately or it may not take effect until a later date, for example on retirement of the scheme member of the scheme member’s death.
If the scheme member subsequently transfers benefits which have an earmarking order attached, the order must also be passed to the new scheme. The ex spouse must be advised of any transfer within 14 days of the date of transfer.
What can be covered by earmarking?
Pension commencement lump sum
Lump sum payments on death before retirement
What can’t be covered by earmarking?
State benefits, including State Second Pension.
Dependants pensions payable on death (either before or after retirement)
Advantage of earmarking
The ex spouse can receive a benefit if the member has further contributions and growth after the divorce.
Disadvantages of earmarking
The scheme member is the owner of the pension rights and has full control over the pension.
This means the ex spouse who has been granted a court order for pension earmarking has no control over the investment decisions. If the scheme member has a very different attitude to risk than the ex spouse, the ex spouse will end up with a very unsuitable pension portfolio.
The ex spouse is not entitled to income until the scheme member decides they wish to draw income. If ages and personal circumstances between the member and the ex spouse are very different, this may cause big problems for the ex spouse. For example, if the scheme member plans to continue working when he/she reaches retirement age or has other assets, he/she may not wish to draw on the income until a later age. The ex spouse may have no other income and be reliant on the pension income at a certain age.
Pension income drawn from the scheme is deemed to belong to the scheme member, and is therefore taxed at the scheme member’s marginal tax rate. For tax purposes, the scheme member is deemed to have received all of the pension benefit before passing the relevant portion of it to their ex spouse. If the scheme member is a 40% taxpayer and the ex spouse is a basic (or nil rate) tax payer this will result in a much larger percentage of the pension income being subject to tax than it would be directly in the hands of the ex spouse. This excess tax is not reclaimable.
Earmarking does not result in a clean break between the parties. Some ongoing contact between the 2 parties will be necessary.
The order for pension income will lapse on the death of the scheme member, even if payments have already started.
Pension benefits will cease on remarriage of the ex spouse.
Pension benefits revert to the scheme member on the death of the ex spouse.
If you are going through a divorce and would like to discuss your options relating to a pension please do contact me on 01932 698150 or email firstname.lastname@example.org.
My guide Pensions and Divorce can be downloaded here.