Vince Lane explains why the new rules on pensions give divorcing couples useful new options when arranging their finances.
I’ve been working as an adviser to people going through divorce for over 20 years now, and throughout that time I’ve become used to reacting to the regular changes in the options for divorcing couples in dealing with their pensions. When I first started in the field, pensions were highly inflexible investments and there were only two real options – offsetting the value of one person’s pension against an asset retained by the other, often the house; and pension earmarking, which required a proportion of one person’s pension to be paid to the other but had significant disadvantages, and inflexibility.
We then saw the introduction of pension sharing orders, which are very common now in divorce and have gone a long way towards reducing the unfairness that often occurred when one person’s large pensions couldn’t previously adequately be divided up. For many couples, particularly those some way from retirement age, pension sharing is still likely to be the best option on divorce.
However, the new flexibility available to those aged 55 and over in defined contribution schemes, (such as personal pension plans) goes further in expanding the range of options. Since 6 April 2015, pension investors have total freedom over how they take an income or a lump sum of capital from their pension, effectively freeing up the pension as an asset for potential immediate use by either or both former spouses, subject to taxation. These new provisions offer a new set of choices for those nearing retirement age and going through divorce.
A pension investor can now take the entire pension fund in one go, if necessary or desirable. The first 25% will normally be free from tax, and the balance taxed as income at the individual’s marginal rate. Alternatively the pension fund could be taken in smaller lump sum amounts at irregular intervals, which may be useful for example to fund loan repayments, or larger cash flow issues. Again, typically the first 25% of each withdrawal is tax-free with the balance taxed as income. Alternatively, an individual might take 25% in the form of a tax-free lump sum and take a regular taxed income from the balance of the fund, or buy an annuity if a guaranteed income is needed.
Pensions are complex products and, for those with significant amounts of money tied up in them, they need careful handling on divorce. The beauty of the collaborative process is that both spouses have the opportunity to sit down with their lawyers and a pensions expert like myself, in a calm and constructive atmosphere, to work out the most efficient way to deal with these assets from all the different options available. This increased pension flexibility is another tool in the toolbox of the Creative Divorce professionals to enable progress towards a fair and cost-effective settlement that is acceptable to the whole family.