Wealthy investors who have accumulated significant retirement savings are increasingly raiding their pensions to pay off their spouses in divorce cases.
Since 2000, couples who file for divorce have been able to carve up pensions savings between them as part of their separation settlement. Previously the entire pension was typically taken by one spouse, and offset by the other receiving a bigger share of another asset such as the property.
Financial advisers say awareness of this ability to “pension share” has grown rapidly over the past few years and these investments are now commonly a crucial consideration in divorce cases.
This is partly due to the fact that English courts have recently been granting significantly more generous divorce settlements to lower earning spouses. A couple’s total assets are now much more likely to be split equally, rather than according to the needs of the recipient.
Also, the pension contribution rules introduced in April last year have significantly enhanced the amount people can save tax- efficiently for retirement. As a result pension schemes are taking an increasingly important role in many families’ wealth planning.
Peter Smith, regional director of Hill Martin, the financial planning firm, says: “Pensions now have to be an important consideration (in divorce) because of the capital value attached to them.” Smith says he is doing up to 20 times more business in the area of pensions and divorce than he was five years ago.
The big bonus for investors who give a slice of their pension to their former spouse is that they can rebuild their pot in a tax-
efficient way. The A-day pension rules mean that anyone can build a pension fund up to a current limit of £1.6m. If someone gives, say, half of their pot to a partner in divorce, they can then replenish these funds, and get tax relief, as long as they stay within the annual contribution limit (currently £225,000).
Daniela Glover, a specialist in pensions and financial planning at Smith & Williamson, says: “If a (higher rate taxpayer) gives their spouse £100,000 of savings it will cost them £100,000. But if they give £100,000 of pension it will only cost them £60,000.”
Sharing pensions can also help couples to make a clean break from each other financially. Previously, before pensions could be shared, there may not have been sufficient liquid assets to pay the spouse off at the time of divorce, and so couples may have been tied into an ongoing maintenance agreement. But the ability to tap into pensions means people can fund larger settlements.
Parting with a share of your pension as an alternative to other assets can also reduce the immediate financial impact of the divorce settlement.
“Unless you have already reached 50, pensions are not spendable money. Drawing from your funds may not immediately affect your standard of living,” says Smith.
A secure retirement income is also likely to be welcomed by a lower-earning spouse. “At least if they have some pension savings from the divorce it takes the pressure off ongoing saving,” says Glover.
Julian Lipson, a partner in the family team at Withers, says that couples tend to favour an equal split of the “good” liquid assets – such as savings, investments and property and the more “boring” pension-type assets.
“Pension sharing enables people to fund divorce more creatively,” he says.
If you do want your pension to form part of any divorce settlement, it does, however, require some careful planning. Different types of pensions – money purchase schemes and final salary schemes – are treated differently, and working out how much each spouse is entitled to is complex.
Smith says: “There are so many technical points. You must have a pensions expert.”
For money purchase schemes the starting point is the cash equivalent transfer value of the pension fund. For final salary schemes the actual worth of the benefits payable needs to be worked out. These figures are typically calculated by an accountant, and form the basis for working out how much each individual should receive.
But even once these figures are obtained, it is not as easy as splitting the pot down the middle.
Lipson says: “Pensions are generally split in such a way to achieve parity of income rather than parity of equity capital. It is not as simple as giving 50 per cent of the existing pension value to each partner.”
This is because women typically have longer life expectancies and therefore receive a less generous pension income than men from the same amount of capital.
But some pensions experts say the very fact that women are likely to have their retirement income for longer means they should not have an equal income to their former husband.
The division of pensions can be made even more complicated if there are illiquid assets such as commercial property held within the scheme.
Usually once the amount the recipient is entitled to has been calculated, they can move it to a new scheme with the same provider or invest it with a different pension company. Some final salary pension schemes allow the second spouse to keep their funds within the existing scheme, and take their share of their benefits when they retire. Smith says doing this can yield a better return, but is only offered by the most generous schemes.
If the pension is already being paid to one spouse, it can prove even harder to split.
Before you start thinking about splitting your retirement fund you would be wise to seek the advice of a specialist pensions adviser. There is a growing awareness among divorce lawyers regarding the issue of pensions, but still not all are experts in the field.
Smith says that anyone wanting to split a pension needs to make this clear early on in the divorce proceedings as it can take a “tremendous time” to gain transfer values.
“Some pension schemes are not at all prepared for dealing with divorce. It is like they are tackling it for the first time every time,” he says.