Pension Planning & Divorce: Separating Pension Assets
It’s important to understand how pensions work across life’s major twists and turns.
Without emotion, let’s discuss pensions & divorce.
The Value of Pension Assets
Pensions are a long-term investment vehicle and valuable personal asset. They form an important part of a family’s long-term financial security and subsequently, often become a contentious point in divorce.
If your pension funds are of significant value it is essential you consult with a financial adviser to work alongside your legal advisor, in preparation for divorce.
It is important to assess the long-term value of your pension assets and understand their weight in the fair separation of money. While family solicitors are of great benefit in supporting communication and establishing legal rights, a financial planner will help in valuing pension and investment assets – for current and future planning.
Tax Planning with Pension Assets
For the wealthy, a key consideration of asset retention should be tax. Pensions operate under their own tax regime. Personal tax positions should be considered where large funds are under dispute.
If you hold a large amount in pensions, you may have a potential Lifetime Allowance tax liability. Post-pension sharing order, a pension value will have reduced, so reducing its LTA tax risk. Post-sharing order, a UK taxpayer could further benefit from making tax relievable pension contributions, from non-pension settlement proceeds. A good financial planner will guide you through your separation options and the benefits and drawbacks of each, for your independent financial security.
Legal Separation of Pension Assets for Divorce
There are essentially three ways that pension assets can be separated for divorce:
- Pension Sharing
Pension Earmarking & Earmarking Orders
What is a Pension Earmarking Order?
Earmarking is where one party retains the right to another’s asset in the future. An earmarking order is dependent on the person holding the pension starting, ‘opening’, their pension. The earmarking right may be to their ex-partner’s Pension Commencement Lump Sum at retirement, but they would not typically have control over when that ‘retirement’ age would be.
An earmarking order is not good for emotional separation as it doesn’t allow a ‘clean break’ and is dependent on the compliance of the other party. The couple essentially is tied until the party holding the pension decides to take their pension. The party holding the pension asset effectively retains control over their ex-partner’s access to the money.
Pension earmarking used to be available across the UK, but is now only available in Scotland. While you may hold an income earmarking order, it is now only available to be used for a pension lump sum.
Examples of pension earmarking orders in practice
Gemma & Jamie divorce when Gemma is 40 and Jamie is 50 years old. Gemma is entitled to half of Jamie’s Pension Commencement Lump Sum at his retirement under their earmarking agreement.
Possible (positive) Scenario 1:
Jamie opens his pension at age 55, and Gemma gets half the lump sum, even though she is only 50, and under minimum pension age at the time.
Possible (negative) Scenario 2:
Jamie decides to use other assets for his retirement income, and doesn’t open his pension until he reaches 75 years. Gemma must wait until Jamie opens his pension to receive her divorce benefit.
Pension Sharing Orders
What is a pension sharing order?
A pension sharing order offers a ‘clean break’. In a divorce settlement, a percentage share of a pension is decided. A Sharing Order certificate is produced and presented to a pension provider for the legal separation of the benefits. This results in one pension separating into two, with each party having their own pension plan.
Examples of pension sharing in practice
Claire & Chris divorce, agreeing for Chris to get 30% of Claire’s Civil Service pension, and 40% of her Legal and General Pension Fund.
In this scenario, Chris would get a Pension Sharing Order scheduling the agreement and be able to present this to each of Claire’s pension providers.
As the Civil Service Pension is a defined benefit scheme, Chris gains his own Civil Service rights – an income for life from a pre-defined age, totally separate from Claire’s. The Civil Service Pension calculate Chris’s new benefits and deduct the appropriate amount from Claire’s income.
The Legal and General pension is a pension ‘pot’, and so the fund is split accordingly. This results in Claire and Chris each having their own pension with L&G.
Pension & Asset Offsetting
What is offsetting in divorce?
Pension offsetting is sharing assets without having to split them. It works best for couples with a large asset portfolio or significant cash holding.
Examples of offsetting in practice
Shelley and Andy have decided to separate their assets by offsetting. As a wealthy couple, they have several properties, cash, pensions and other investments.
It is decided that Shelley will keep the main residence, long-term investments and an amount of cash, while Andy will retain his pensions and the rental properties. Without splitting the pensions, Shelley and Andy have offset their assets by agreement.
The Pensions Advisory Service have a great factsheet summing up pensions and divorce. For more information about pension and retirement planning; tips and techniques used by professional advisers, request our FREE guides. All of our guides, articles and blogs are written by qualified & practicing industry professionals.