New rules that loosen the previously rigid framework surrounding pensions have potential benefits for those coping with the breakdown of their marriage. This makes it all the more important that people receive expert financial advice as well as the best legal counsel to make sure they get the best for themselves and their dependants, argue Turcan Connell Group partner and family law specialist Gillian Crandles and financial planner George Martineau.
Divorce is a traumatic time for all of those involved. Dividing up the assets of the two parties can be difficult. But with the right advice, especially in relation to financial assets, a solution can generally be found that can satisfy both parties. The recent changes to pensions legislation, which makes them much more than just a tool for retirement saving, can help considerably in forging an agreement that benefits everyone.
The reason for this is the increased flexibility. Scottish law dictates the general principle that the assets of the marriage should be distributed fairly between the two parties, with ‘fair’ being treated as equal in the absence of special circumstances (which might include substantial assets brought into the marriage, rather than acquired during the marriage, or where one party has been economically disadvantaged in the marriage by giving up a career). But often the economic needs of the two parties are quite different at separation – for example, where one is in full employment and the other looks after the household. The flexibility granted by the changes in pension legislation give those of us working with the parties more creativity to help them find a solution that meets everyone’s individual needs best.
What are the pension changes?
They come in two main groups, with the first set applying to how people can spend their pension during retirement. So-called flexi-access drawdown means that from April anyone over 55 will be able to take money out of their pension pot as and when they wish. In other words, instead of drawing on a pension in fairly rigid yearly amounts, they will now be able to take whatever proportion they want in lump sums or as steady income (it should be borne in mind that, in most cases, 75% of a pension is susceptible to income tax – the more someone takes out in any year, the more they expose themselves to a greater tax bill).
The second set of changes applies to how pensions can be passed on at death. The previous framework meant that crystallised pension funds (those where the retiree had started drawing on savings) faced a punitive 55% tax charge when passed on to anyone other than a spouse, civil partner or dependent children. That tax charge will be abolished this year, making pensions a very attractive method of passing assets between generations (for those who die before 75 the beneficiary doesn’t have to pay any tax when they draw on the pension – for those who die aged 75 or older the beneficiary pays tax at their marginal rate). As a pension can now be passed on to someone outside of marriage that can be attractive for those who are moving out of a marital relationship.
Most importantly, whenever part of a pension is transferred to another party in a divorce settlement, the beneficiary can avail of the new pension rules as if that pension had been built up in their own name. So, for example, if the person who built up the pension is younger than the former spouse who is receiving part of the pension in a settlement, the spouse can start drawing down the pension when they reach 55 in whatever way they want and not have to wait until the original pension saver reaches retirement age.
So where would these changes potentially benefit someone in a divorce situation?
Often the key priority for divorcing parties is to ensure that each of them is left with a suitable home. The greater flexibility in drawdown now means that anyone with a pension has access to a lump sum in their mid-50s, allowing them, if they are 55 or above, to use some of that money to reduce the immediate financial burden of buying a new property. If they are younger than retirement age, the pension gives them the peace of mind that should they need to increase their mortgage burden now, they have assets that can help pay this off in the future. (It’s important to remind ourselves however that pension money spent earlier leaves less available for later life and that the more money someone takes out in any one year, the more they may have to pay as tax.)
The removal of the tax burden on passing on a pension gives people generally – not just divorcees – greater flexibility in how they use that money. For older retirees, where the pension isn’t likely to be drawn down in its entirety during their lifetime, that pot of savings has now become an important tool that can be used to pass on money to children and grandchildren. For divorced individuals going into further marriages where additional or stepchildren might come into the equation, diverging obligations to the next generation may emerge. Each party can therefore choose to pass on their pension money after their death to whomever they wish.
For the owner of a large pension, splitting the pot on divorce can be useful because it allows them to reduce their pension assets if they are getting dangerously close to the pension lifetime allowance (currently £1.25 million). If they still have a number of years before retirement and a sizeable income, this then gives them the space to build up their pension savings again. The bottom line is that the two parties are able to benefit from a larger amount of tax-free savings.
Of course, the issue of dividing up a pension can be very complicated and for splitting defined benefit or final-salary pension schemes we often recommend consulting with an actuary to properly value the pot. However, we feel strongly that anyone in marital breakdown with significant financial assets needs the benefit of precise financial advice as well as expert legal counsel. With the input of both, these new pension changes can help people facing divorce make better, more flexible choices as to what assets they need, and help both parties ensure they have the resources to meet their changed circumstances.