This guide is for financial advisers only. It mustn’t be distributed to, or relied on by, customers. It is based on our understanding of legislation as at May 2023.
Pension earmarking (also known as pension attachment) was introduced as an option for divorcing couples in July 1996 in England and Wales, and in August 1996 in Scotland and Northern Ireland. Please note that earmarking is now termed attachment in England, Wales and Northern Ireland but not Scotland. For the purpose of this article, we have referred to pension earmarking throughout but this includes pension attachment. Differences in the legislation between Scotland and the rest of the UK are highlighted, where relevant.
Pension earmarking allows the courts to make an order requiring part, or all, of the member’s pension benefits (except the state pension) to be paid to their ex-spouse or ex-civil partner when they become payable.
In England, Wales and Northern Ireland, an earmarking order can take effect on:
- divorce, annulment or on judicial separation, in connection with a marriage, or
- dissolution, nullity or separation order in connection with a civil partnership
However, in Scotland, an earmarking order can only be put into effect on:
- a divorce or annulment in connection with a marriage, or
- dissolution of a civil partnership
Throughout this article we intend the reference to ex-spouse or ex-civil partner to include those subject to an order due to separation in England, Wales and Northern Ireland.
In England, Wales and Northern Ireland it’s possible to make an earmarking order on:
- a tax-free lump sum
- the income payable on taking pension benefits
- a lump sum payable on death before taking pension benefits
An order could state that the ex-spouse or ex-civil partner is to receive all or part of each of the above three benefits or could mention only one or two of them – it depends on what's agreed between both parties.
In Scotland, it isn’t possible to earmark pension benefits; only lump sum benefits on retirement or death can be made subject to an earmarking order.
The terms of the order and the type of pension arrangement will determine who is responsible for complying with an earmarking order.
Some orders oblige a member to pay part, or all, of their benefits to the ex-spouse or ex-civil partner when they receive them. That means there’s no obligation on the trustees/managers of the pension arrangement and they may be unaware of the existence of the earmarking order.
More commonly, however, when an earmarking order is issued it’s the responsibility of the trustees/managers of a pension arrangement to pay benefits direct to the ex-spouse or ex-civil partner when they become payable.
For an occupational pension scheme, it’s the trustees who should be served with the earmarking order, and they’re responsible for carrying out its terms. For a retirement annuity policy, a buyout contract, a personal pension, a stakeholder or a policy assigned to a member from an occupational pension scheme, the earmarking order should be served on the provider, who is then responsible for compliance.
When the benefits start to be paid
Under earmarking the ownership and control of the pension arrangement remain with the member, and it is he/she who must decide when the benefits come into payment (subject to legislation/scheme rules). This is the case even where 100% of the benefits have been earmarked for the benefit of the ex-spouse/ex-civil partner. We can only accept instructions from the member with regard to the timing of taking benefits and any changes in investment choices.
Taxable pension or income payments payable to an ex-spouse or ex-civil partner still ‘belong’ to the member. Pension or income will therefore still be taxed as if it’s being paid direct to the member. It shouldn’t count as taxable income for the ex-spouse or ex-civil partner and shouldn’t be declared as such to HMRC.
If the member dies before taking pension benefits, any provisions in the earmarking order relating to a tax-free lump sum and/or pension will no longer apply. If the lump sum payable on death has been earmarked for the ex-spouse/ex-civil partner, the trustees/provider should comply with this provision in the order.
If there is a provision in a court order for paying part, or all, of a lump sum on death before taking pension benefits to an ex-spouse/ex-civil partner, this is assumed not to apply once the member has moved funds into drawdown.
Normally the provisions of the earmarking order relating to pension payments will no longer apply.
The provisions of the order relating to a lump sum payable on death or at retirement can survive the remarriage, or death, of the ex-spouse (or the ex-civil partner entering into another civil partnership or dying) but the terms of the order should clarify this point.
The ex-spouse or ex-civil partner (or their representatives if they die) must notify the trustees/managers that the order is no longer in effect within 14 days of such an event.
A member’s right to make a transfer isn’t affected by the existence of an earmarking order. Where a full transfer is made to an alternative pension arrangement, regulations say that the order moves with the transfer. It then applies to the receiving scheme, as long as the transferring scheme notifies both the receiving scheme and the ex-spouse or ex-civil partner within 21 days of the transfer being made. The receiving scheme should be provided with a copy of the order as part of the notification process.
The receiving scheme would need to look at the order and make sure it is possible to comply with its terms in relation to the pension arrangement the transfer is being applied to. The order will specifically mention a scheme or provider name and scheme or policy number that is being earmarked. Once a transfer is made, the terms of the order apply to the receiving arrangement but the wording in the order is not amended. It is therefore important for a receiving scheme to document what funds are earmarked in the receiving arrangement particularly if other transfers or contributions are made to the same arrangement.
Where only a partial transfer is made, regulations state that, the order will stay with the original scheme. However, the transferring scheme must notify the ex-spouse or ex-civil partner of what has happened, and provide a note of the name and address of the receiving scheme, within 14 days of the transfer being made.
Occasionally an earmarking order will require the consent of the ex-spouse/ex-civil partner before the transfer is made.
Most earmarking orders were written before the existence of pension benefits such as uncrystallised funds pension lump sum (UFPLS) or flexi-access drawdown. The exact wording of existing earmarking orders is crucial in determining the effect of taking one of these benefit types.
If an earmarking order requires a percentage of the income (England and Wales) to be paid to the ex-spouse or ex-civil partner when benefits are taken, it may be that interpretation of the exact wording of the order would lead the trustee/manager of the pension arrangement, where given responsibility to comply with the court order, to believe it applies to any income payable, whether by annuity or via flexi-access drawdown.
The same may apply to any earmarking orders made on lump sums when benefits are taken. Any such order would continue to apply to any tax-free lump sum taken, but depending on the exact wording used the trustee/manager may believe it also applies to any uncrystallised funds pension lump sum (UFPLS) or small pots lump sum paid. It is very likely that the trustee/manager will seek clarification of any ambiguous wording in advance before any benefits are settled and the order followed.
It’s worth noting that the trustee/manager must tell the ex-spouse or ex-civil partner if an event occurs that is likely to result in a significant reduction in benefits, providing the reason for the reduction. This would allow the ex-spouse or ex-civil partner to apply to the court for a variation of the existing order if necessary.
It’s possible for both parties to come to a financial agreement some years after the order has been made which means it no longer applies. Alternatively, an order can be varied through the courts. It would be the percentages on the existing order that would be varied as opposed to new terms being set.
Whilst an earmarking order applies, it would not be possible to effect a pension sharing order on the same pension arrangement.
If a member wants to replace an earmarking order with a pension sharing order then this would need to be done through the courts. Note – a pension sharing order can only be made where a divorce petition was filed on or after 1 December 2000 meaning it would not be possible to replace an earmarking order with a pension sharing order if a divorce petition was filed before that date.
On a benefit crystallisation event, the benefits being taken are tested against the member's lifetime allowance, even though all or part of the benefits will subsequently be paid to their ex-spouse or ex-civil partner. So, there is no lifetime allowance test on the ex-spouse or ex-civil partner for the benefits they receive from the earmarking order.
New earmarking orders can still be made although these tend to be rare in practice. Many earmarking orders tend to be dated between 1996 and 2000 prior to pension sharing becoming an alternative option.
A more common occurrence is having to deal with a transfer where there is an earmarking order on the benefits being transferred. In either of these scenarios, Aegon has to comment on the order and point out whether there would be any issues in complying with its terms.
Aegon also has to make sure that the correct options are quoted and the correct benefits are settled when dealing with any transfer, retirement or death quote or claim involving a contract that has an earmarking order on its benefits.