Pensionable salary definitions and unwelcome surprises in CETVs

Blog 24 Feb 2011 By
Couples who are going through divorce proceedings, and their solicitors, will know that if there are pension assets to be considered then the Cash Equivalent Transfer Value (CETV) of these assets must be obtained from the relevant pension scheme. If you or your (ex) spouse is a member of a final salary pension scheme then beware the dangers of not knowing the definition of “Final Pensionable Salary” (FPS) within the scheme. This is of particular importance to those members who have been “acting up” to a position for a period of time where they receive a higher salary than usual for that period, but return to their normal salary after the period of “acting up”.

If the definition of FPS contains any reference to “the best” or “highest of”, for example, 5 years, and you are close to retirement and/or implementing a pension sharing order then pay close attention!

If you have been acting up to a more senior role than usual and have since returned to your usual role then you need to know when you will lose the benefit of the higher salary being included in your FPS as this could have a significant effect on both your CETV and pension – in the event of a pension share, the % calculated to achieve a specific objective such as equality of income could actually result in something far removed from that objective if agreement (whether offsetting or pension sharing) is implemented on the basis of a temporarily inflated CETV. This could have a significant impact on retirement plans once the true facts emerge from the pension scheme.

Example – Gordon’s story

Gordon is a member of a public sector pension scheme, where Final Pensionable Salary (FPS) is defined as the best of the last 3 years’ salary. Gordon is entitled to a pension of 1/80th of his FPS and a lump sum equal to 3 times his pension. He is currently aged 57, has completed 22 years of service and acted up to a higher position for 1 year.

Gordon is currently involved in divorce proceedings and has requested a CETV from his pension scheme. If Gordon’s annual salaries for the last 3 years had been £68,000, £100,000 and £70,000, then he would be entitled to a CETV in the region of £615,000 – calculated on a FPS of £100,000 and therefore a pension of £27,500 per annum. Based on this CETV and a pension share of 50%, the pension credit awarded to Gordon’s ex-spouse would be £13,750 per annum and a pension debit of 50% would be awarded to Gordon, the expectation of both parties is that the pension accrued to date has been shared equally and will provide broadly equivalent incomes, Gordon expects to increase his pension as a result of 3 further years accrual of benefit.

In the three years to retirement, Gordon’s annual salaries were £70,000, £72,000 and £75,000. At retirement Gordon believed that he had given up half of his pension built up to age 57 and so reckoned that his pension would reflect half of his service to age 57 plus 3 years – so based on 14 years adjusted service he expected to receive a pension of £13,100 per annum.

However when Gordon retired at age 60 he was surprised to find that he will actually only receive a pension of approximately £8,800 per annum – 33% lower than expected. The reasons for this reduction lie in the pension credit awarded to Gordon’s ex spouse – the pension credit was based on the CETV which included Gordon’s high salary of £100,000, and so the deduction from Gordon’s pension also reflects this high “one off” salary, further, the pension debit will also have increased in line with price revaluation from the date of implementing the Pension Sharing Order.

Had this potentially significant reduction to Gordon’s pension income been noticed at an earlier stage of divorce proceedings, the split of other assets between the divorcing couple may have been different, and indeed fairer. As it turned out, acting up proved costly to Gordon.

Spence and Partners can provide advice on the suitability of the CETV obtained as well as reports covering the issues of Pension Sharing and/or Offsetting. If you would like any actuarial advice in relation to Pensions on Divorce, contact our Divorce Team who will be happy to help.

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