Apparently in legal circles the first working Monday of the year is dubbed ‘divorce day’ as lawyers typically see a spike in enquires from couples seeking professional advice about divorce. Some, however, chose not to wait until the festive period was over as official figures showed that thirteen people filed for divorce on Christmas Day!
It is not all doom and gloom though. The latest figures from the Office of National Statistics show that divorce rates in England and Wales are at the lowest rate since 1973.
Courts can consider most pension rights during a divorce. It is important to note that divorce law for pensions differs between Scotland and the rest of the UK. The Scottish deviations not being covered below.
There are three ways pension benefits can be shared between divorcing spouses, which are:
An attachment order (sometimes called ‘earmarking’)
Perhaps the most simple method as this avoids the complexity of splitting a pension. Here the value of the pension (usually expressed as a cash equivalent transfer value for final salary schemes) can be offset against other assets when the total matrimonial estate is divided. This allows the pension member to keep their pension benefits whilst the ex-spouse receives other assets of equivalent value instead.
The value of the members' pension is calculated at the date of divorce and a common asset to offset against is the matrimonial home, which would mean the ex-spouse retaining a larger share of the house, for example.
Attachment (or earmarking) order
Once a cash equivalent transfer value (CETV) or fund value for personal pensions has been obtained, the court decrees that a specified percentage of the member's pension benefits are paid to the ex-spouse when the member begins to draw benefits. For example, at age 60 the member is set to be paid £20,000 pension income a year. If the ex-spouse was awarded 50% of the members pension, they would receive an income of £10,000 directly from the scheme once the member reaches age 60. This pension income would be subject to the same increases in payment that the member would be entitled to.
A benefit of this arrangement for the ex-spouse is that they acquire their own pension benefits which is particularly useful if they did not build up their own during the marriage. Furthermore, if the ex-spouse joins the members pension scheme, they will enjoy the same increases to the annual pension income as the member is entitled to, which can be an extremely valuable benefit especially as final salary style pension schemes are becoming more scarce.
Points of note & considerations:
- As part of the divorce settlement the member may have to swap or ‘commute’ part of their pension income for some tax-free cash when benefits are taken.
- An agreed percentage of any lump sum death benefits payable on the members death must be paid to the ex-spouse if the member dies before retirement. Such an order could give rise to some inheritance tax issues, which are beyond the scope of this article.
- Attachment order become invalid on remarriage of the ex-spouse in relation to regular pension income. However, any tax-free cash may still be payable.
- The order would also lapse on death of the member meaning the ex-spouse may no longer receive a pension income even if this was already in payment.
- The member can take the pension benefits whenever they decide to (subject to normal HMRC rules), which could mean delaying taking the pension. This would be problematic if the ex-spouse is reliant on the income.
- The ex-spouse has no control over the investment strategy of the pension, meaning the member could deliberately invest in poorly performing assets to diminish the fund value.
Evidently, attachment orders do not provide a ‘clean break’ following the divorce.
Pension sharing aims to give a clean break from the divorce with some of the member’s pension benefits being given to an ex-spouse.
The court decides how much of the member’s pension is to be given to the ex-spouse and the benefits are then divided accordingly. The reduction in the member’s pension is called a pension debit with the rights that are allocated to the ex-spouse being a pension credit.
For final salary style pensions, a cash value of the members benefits is calculated and then the scheme can either allow the ex-spouse to join the scheme in their own right or to transfer a cash lump to another registered pension scheme. Transfers to other pension schemes are usually more common.
Personal pensions have the value of the pot split, with an agreed lump sum transferring to a registered pension held by the ex-spouse. Once the ex-spouse has the pension credit, they can control the investment strategy and the timing of benefits (subject to normal HMRC rules).
Lifetime Allowance Considerations
This has no direct impact of the member’s or ex-spouses Lifetime Allowance.
The pension benefits awarded to an ex-spouse are assessable against the member’s Lifetime allowance and income tax liability. Essentially it is as if the member has made a withdrawal from their own pension, irrespective of if the cash is then given to the ex-spouse.
The cash received by the ex-spouse is tax-free.
Pension sharing has different implications for the member and ex-spouse. For the member, the value of any pension debit will not be assessed against the member’s Lifetime Allowance.
For the ex-spouse, the pension credit will not be treated as a contribution and therefore not assessable against the ex-spouse’s annual allowance.
The pension credit will count towards the ex-spouse’s Lifetime Allowance if the credit was received after 6th April 2006.
Lifetime Allowance Protection
Following reductions in the Lifetime Allowance, transitional protection regimes were introduced. Divorce can impact clients with Lifetime Allowance protection in place. This is beyond the scope of this article and should be discussed further with a financial planner or tax professional.
To discuss your pension or retirement planning, contact us.
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