Pensions and Divorce

A look at the issues around pensions and divorce and the options available.

Key Points

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There are three ways that pension benefits can be dealt with on divorce – offsetting, earmarking and pension sharing (or pension splitting).

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Be aware of the impact of the Pension Freedoms legislation on existing earmarking orders – for example, an UFPLS is not classed as an income payment allowing an individual to take money from a pension while possibly circumventing the order.

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For pension sharing order benefits crystallised post A-Day – it is still possible for an exspouse to apply for the lifetime allowance enhancement factor.

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The rules in Scotland are different to those in the rest of the UK.


Introduction

There has been various legislation introduced that has impacted on pensions:

IMPACT OF LEGISLATION

  • Pensions Act 1995 – introduced earmarking
  • Welfare Reform and Pensions Act 1999 – in force from 1 December 2000 introduced pension sharing
  • Civil Partnership Act 2004 – extended to cover civil partnerships
  • Marriage (Same Sex Couples) Act 2013 – extended to cover same sex marriages

The recent pension freedoms have also affected existing earmarking orders.

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What are the options?

THERE ARE THREE MAIN WAYS PENSIONS CAN BE DEALT WITH ON DIVORCE:

  • Offsetting
  • Earmarking
  • Pension sharing

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Offsetting

HOW DOES IT WORK?

  • Pension benefits are valued as at the date of divorce or (date of official separation in Scotland)
  • The existing pension assets can then be included alongside other matrimonial assets
  • The member may then be able to keep their pension assets by offsetting their value against other matrimonial assets

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Offsetting - benefits and drawbacks

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Earmarking

HOW DOES IT WORK?

  • The court agrees a percentage of the members’ pension (and/or lump sum) benefits to be earmarked for the ex-spouse (this is not restricted to the duration of the marriage)
  • When the member retires and takes their benefits, a proportion (the agreed percentage) is paid to the ex-spouse
  • The order can insist the maximum tax-free cash is taken or restrict the level of tax-free cash taken
  • The pension income is taxed at the marginal rates of the member before the earmarked amount is passed to the ex-spouse

SCOTLAND – DIFFERENCES

  • Normally tend to Use the date of official separation or the date of the petition
  • Take into account only benefits earned during marriage
  • Only earmark tax-free cash and lump sum death benefits (not pension income)

Earmarking - benefits and drawbacks

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Pension sharing

HOW DOES IT WORK?

  • Allows member to split their pension and provide exspouse with proportion of their pension in their own rights
  • Part of the member’s pension benefit is reduced by pension debit; and
  • Ex-spouse acquires a pension credit
  • Both member and ex-spouse now have total control over their corresponding pensions

THINGS TO BE AWARE OF

  • Can only be made in a UK court (or legally binding agreement in Scotland)
  • Cannot be made on pensions already subject to an existing earmarking order
  • Cannot be applied to survivors, pensions

WHAT INFORMATION IS REQUIRED?

  • Basic detail in relation to the ex-spouse, for example their contact details, name, date of birth and NI details
  • Copies of the relevant documentation, for example the pension sharing order, the decree absolute and whether or not any appeals to the order have been made
  • On receipt of an order a scheme has four months to implement it

PENSIONS IN PAYMENT – THE DISQUALIFYING CREDIT

The fund is valued for pension splitting purposes

The members’ benefits (for example the original annuity) is revised down accordingly

The ex-spouse now receives a pension credit (an uncrystallised fund value); but

This will have a disqualifying credit – which means there will be no tax-free cash payable when the ex-spouse decides to take their retirement benefits


Pension sharing - the lifetime allowance and transitional protection

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Pension sharing - benefits and drawbacks

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Planning considerations

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PENSION PLANNING CAN HELP CLIENTS:

  • Identify the importance the role their pensions play as part of their total assets
  • Determine whether protecting their pension benefi ts is an option
  • Understand the implications where lifetime allowance protections are in place

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PENSION PLANNING CAN HELP CLIENTS:

  • Understand the value of guarantees and index-linking
  • Understand the clean break principle
  • Understand the issues impacting existing earmarking orders due to changes in pension legislation

This briefing note is also available as a PDF

This document is based on Canada Life’s understanding of applicable UK tax legislation and current HM Revenue & Custom’s practice, as at August 2019 and could be subject to change in the future. It is provided for professional advisers only. Any recommendations are the adviser’s sole responsibility.

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