When it comes to dealing with pensions in your divorce, there are many ways you can approach them. Two of the most common approaches are pension sharing and pension offsetting. It is important to understand the difference between them as the choice you make will significantly impact your financial security.
This article explains what pension offsetting is, how it differs from pension sharing, when it might be appropriate, and why you need to be very careful before agreeing to offset a pension against other assets.
What is pension offsetting?
Pension offsetting means that one person keeps their entire pension, while the other person receives a greater share of other assets to compensate for not receiving any pension.
Instead of dividing the pension, you divide other assets differently to balance things out. In practice, however, it's considerably more complex than it first appears, and it comes with significant risks that you need to understand before agreeing to it.
How pension offsetting works
The basic principle is that the value of the pension is taken into account when dividing the other matrimonial assets, particularly the family home or savings.
Here's a simplified example. Let's say you and your spouse have the following assets:
- Family home with equity of £300,000
- Your spouse's pension valued at £200,000
- Your pension valued at £50,000
- Total assets: £550,000
Without any offsetting, a straightforward equal division might give each person £275,000 worth of assets. This could be achieved by sharing the house and sharing the pensions.
With pension offsetting, your spouse keeps their entire pension (£200,000) and you keep your smaller pension (£50,000). To compensate for the £150,000 difference in pension values, you receive a larger share of the house. So instead of each getting £150,000 from the house, you might receive £225,000 and your spouse receives £75,000.
Both of you end up with assets worth £275,000, but you have more property and less pension, while your spouse has less property and more pension.
The fundamental problem with pension offsetting
The example above makes offsetting sound neat and fair. Both parties get the same total value of assets. But there's a fundamental problem that needs to be clearly understood.
A pension is not the same as capital. They are different types of assets with different characteristics, different tax treatment, and different purposes. Receiving £200,000 worth of property is not equivalent to receiving £200,000 worth of pension, even though the numbers look the same.
Pensions provide income, property doesn't
This is the most important point. A pension is designed to provide you with an income throughout your retirement, potentially for 30 or 40 years. Property is a capital asset. You can live in it, but it doesn't generate income unless you sell it or rent it out.
If you accept a larger share of the house instead of receiving a share of your spouse's pension, you might have somewhere to live, but you won't have pension income in retirement. When you reach 70 or 75 years old, you'll be living in a house but struggling to pay for heating, food, and other living costs because you have little or no pension income.
Your ex-spouse, meanwhile, will have a comfortable retirement income from their pension. The settlement that looked equal on paper has left you significantly worse off in retirement.
Different tax treatment
Pensions have significant tax advantages. Money saved in pensions receives tax relief on contributions, grows tax-free, and you can take 25% as a tax-free lump sum when you retire. The rest is taxed as income when you draw it, but you're likely to be in a lower tax bracket in retirement than during your working life.
Property doesn't have these tax advantages. If you sell property, you may have to pay Capital Gains Tax. Property doesn't provide tax-free growth in the way pensions do.
When you accept property instead of pension, you're giving up these valuable tax benefits.
The timing issue
You can usually access your pension from age 55 (rising to 57 in 2028), but you might not want or be able to sell your property at that age. Property is illiquid. Converting it into income to live on requires either selling it (and then where do you live?) or arranging equity release or a mortgage, which comes with costs and complications.
A pension is designed to provide income when you need it in retirement. Property is not designed for this purpose.
Property is not a pension
This cannot be emphasized enough. A house is somewhere to live. A pension is income to live on. They serve different purposes. Having a valuable house doesn't help you buy groceries when you're 75 years old and have no income.
Property values might increase over time, but this doesn't help unless you sell the property. Many people who accept offsetting arrangements find themselves in retirement living in valuable houses but struggling financially because they have inadequate pension income.
When might pension offsetting be appropriate?
Despite these significant concerns, there are some situations where pension offsetting might make sense. However, these situations are relatively rare, and you should only consider offsetting after getting proper financial advice about the long-term implications.
When there's sufficient equity in the family home
Offsetting can work if there's a family home with substantial equity and one person wants to keep it. If you need to retain the family home (perhaps because children are living there and you don't want to disrupt their schooling), and there's enough equity to make offsetting work, it might be an option.
However, you still need to be realistic about whether you'll have adequate income in retirement if you give up a share of the pension.
When one or both parties are close to retirement
If you're already at or near retirement age and need capital now rather than future pension income, offsetting might be more appropriate. For example, if you're 64 and need to secure housing immediately, and your spouse's pension is about to come into payment anyway, offsetting might make practical sense.
Even in this situation, you need to carefully consider what income you'll have in retirement and whether it will be adequate.
When pension values are relatively modest
If the pension values involved are small, the complexity and cost of pension sharing might not be worthwhile. For example, if the only pension is worth £30,000, it might make more sense to offset it against other assets rather than incurring the costs of implementing a Pension Sharing Order.
However, be careful not to dismiss pensions as "small" too readily. Even a pension valued at £50,000 can provide meaningful income in retirement.
When both parties understand and accept the implications
If both parties fully understand that offsetting means trading future pension income for capital now, and both are comfortable with this arrangement because it suits their individual circumstances, offsetting can work.
The key word here is "fully understand". Too often, people agree to offsetting without really grasping what they're giving up or what their financial position will be in 20 or 30 years.
When one person has no need for pension provision
In rare cases, one person might already be financially secure for retirement through other means. For example, if you have substantial pension provision from a previous marriage or have independent wealth, you might not need a share of your spouse's pension. In such cases, taking a larger share of other assets instead might make sense.
The serious warning about pension offsetting
Many people, particularly those who have not worked full-time throughout the marriage or who gave up careers to raise children, are tempted by offsetting because they want to secure a home. The desire to keep the family house, or to have enough capital to buy somewhere to live, is entirely understandable and often pressing.
But accepting capital now instead of a share of pension can be a serious mistake that you'll regret for the rest of your life.
Consider what happens 20 years after your divorce. You're in your late 60s or 70s. You own your home outright, but that's all you have. You're living on the State Pension of around £12,000 per year. You can't afford to heat your house properly. You can't afford to run a car. You can't help your grandchildren. You're worried about every unexpected expense. You're effectively living in poverty, despite owning a valuable property.
Meanwhile, your ex-spouse is retired on a pension of £25,000 or £30,000 per year. They're comfortable. They can afford holidays, hobbies, and a good standard of living.
This is the reality for many people who accepted offsetting arrangements without proper advice or without fully understanding the long-term consequences. By the time they realize what they've given up, it's too late to change it.
Property values might have increased substantially, but you can't eat bricks and mortar. The house doesn't pay your electricity bills or buy your food. You're asset-rich but income-poor, which is one of the worst financial positions to be in during retirement.
Before accepting any offset arrangement
If you're considering pension offsetting, you must do the following:
Get proper financial advice
Speak to an independent financial adviser who specializes in divorce. They can model what your financial position will look like in retirement under different scenarios. They can show you, in pounds and pence, what income you'll have at 65, 70, and 75 years old if you accept the offsetting arrangement compared to if you receive a pension share.
This advice costs money, but it could save you from decades of financial hardship. It's money extremely well spent.
Understand what pension income you'll have
Work out exactly what pension income you'll receive in retirement if you accept the offset arrangement. Don't just assume it will be "enough". Get the actual numbers. What will your State Pension be? What will any other pensions you have provide? Is this genuinely enough to live on?
Remember that you might live for 30 or more years in retirement. Your needs might increase as you get older and potentially require care. Will your pension income cover this?
Consider the value difference
Understand that pension offsetting is unlikely to work on a pound-for-pound basis. A pension valued at £200,000 should not simply be offset against £200,000 of property, because they're fundamentally different assets with different characteristics.
A fair offset would need to reflect the fact that the pension provides guaranteed income for life with tax advantages, while property is capital that doesn't generate income. Some experts suggest that offsetting might need to involve receiving significantly more in capital than the pension is nominally worth (perhaps 1.5 or 2 times the pension value) to be truly equivalent.
Your solicitor and any financial adviser you consult should help you understand whether the proposed offset is genuinely fair or whether you're giving up far more than you're receiving.
Think long-term, not short-term
It's natural to focus on immediate needs when you're going through a divorce. Where will you live? How will you manage financially next month and next year? But you must also think about your needs in 20 or 30 years.
Will the decision you're making today provide you with financial security throughout your retirement, or will it leave you struggling when you're in your 70s and it's too late to do anything about it?
Don't let pressure force a bad decision
Sometimes people feel pressured to agree to offsetting because their spouse wants to keep their pension intact, or because the divorce negotiations have been going on for a long time and there's pressure to reach a settlement. Don't let this pressure force you into accepting an arrangement that's not in your long-term interests.
Your financial security for the next 30 or 40 years is more important than reaching a quick settlement. Take the time to understand what you're agreeing to and get proper advice.
Pension offsetting vs pension sharing: a direct comparison
Let's directly compare the two approaches to help you understand the key differences.
Clean break
Pension sharing: Creates a complete clean break. Each person has their own pension and there's no ongoing financial connection.
Pension offsetting: Doesn't create a clean break in terms of retirement provision. One person has a pension, the other doesn't. There's an imbalance in how each person will be provided for in retirement.
Income in retirement
Pension sharing: Both parties have pension provision and will have income in retirement.
Pension offsetting: Only one party has the pension. The other party must rely on whatever pension provision they have independently (which may be minimal) and must manage without the income that the shared pension would have provided.
Control and independence
Pension sharing: Each person has complete control over their own pension and can make independent decisions about retirement.
Pension offsetting: The person without the pension has no pension income to control or decisions to make about pension investments. Their retirement income is limited to whatever they have from other sources.
Risk
Pension sharing: Both parties share in the pension provision built up during the marriage. Both have pension assets that will provide retirement income.
Pension offsetting: The person accepting capital instead of pension takes on the risk of not having adequate income in retirement. They're betting that the capital they receive will be sufficient to meet their needs for potentially 30 or 40 years.
Flexibility
Pension sharing: Each person can access their pension when they reach the minimum pension age (currently 55, rising to 57). They have flexibility about when and how to take their pension.
Pension offsetting: The person receiving capital instead of pension has no pension to access. If they need income, they must find ways to generate it from their capital, which might involve selling assets at potentially disadvantageous times.
Tax efficiency
Pension sharing: Pension benefits remain within the tax-advantaged pension wrapper. The receiving person benefits from pension tax advantages.
Pension offsetting: The person receiving capital instead of pension loses the tax advantages that pension savings provide.
Fairness in practice
Pension sharing: Generally provides a fairer outcome because both parties end up with pension provision for their retirement.
Pension offsetting: Often results in one party being significantly worse off in retirement, even if the paper values looked equal at the time of divorce.
When pension sharing is usually the better choice
In most cases, particularly in longer marriages where pension assets are substantial, pension sharing is the better option because it provides both parties with pension provision for retirement and creates genuine financial independence for both parties.
Pension sharing is usually preferable when the pension holder is significantly younger than their spouse, there's a substantial imbalance in pension provision between the spouses, pension values are large enough that both parties will have adequate provision after sharing, and both parties want a complete clean break.
Getting the right advice
The choice between pension offsetting and pension sharing is one of the most important decisions you'll make during your divorce. It will affect your financial security for the rest of your life. This is not a decision to make based on gut feeling or because it seems like the easier option in the short term.
You need proper advice from a specialist family lawyer who can explain your options and help you understand the implications of each approach. For complex cases or where substantial pensions are involved, you also need advice from a financial specialist who can model the long-term impact of different settlement options.
This information is for guidance purposes only and does not constitute legal advice. We recommend you seek legal advice before acting on any information given.
