Pensions, Divorce and Freedom
A solicitor dealing with divorce may find that the new legislation causes issues which they had not anticipated. Financial advisers can help them through this time by pointing them in the right direction in relation to material which explains the basic changes to legislation but also by pointing out areas which may cause particular problems. This may not just be in relation to current clients but clients who believed that their divorce was done and dusted years ago.
Impact of changes in pensions legislation post April 2015
Although pension legislation has been changed, other relevant parts of legislation (and practice) in relation to divorce have not. It’s too soon for any case law covering interaction between the new pension flexibility and divorce but legal challenge could come. In the meantime, there should be even more focus on ensuring that court orders reflect the intended result, in a way that cannot be frustrated through pensions flexibility. What impact have the changes had on the different types of ways in which pensions can be dealt with on divorce?
Pre April 2015 pensions were not usually valued on a pound for pound basis with other assets, due to the lack of access to the full value. In practice the value apportioned could be anything between 25% and 80% of the fund value and it could depend on how close retirement was. This was discussed in the case of Maskell v Maskell . The County Court Judge had suggested that the pension could be compared on a like for like basis. On appeal, Lord Justice Hope stated that the judge had made the “elementary mistake of confusing present capital with a right to financial benefits on retirement, only 25 per cent of which maximum could be taken in capital terms, the other 75 per cent being taken as an annuity stream“.
However, for those “silver divorcees” who are over 55, there is now total access to defined contribution pension funds. This may lead to value parity with other assets. If so, the tax and future contribution issues surrounding accessing flexibility may need to be addressed in the settlement.
Pension flexibility may have a significant impact on the application of earmarking orders – potentially leaving scope to circumvent the requirements set out in the order, unless the details in the order are very specific.
For example, the pension-owning spouse may be able to avoid the payment of the pension income or Tax Free Cash (TFC) as set out in the earmarking order. This could be done by choosing to take all benefits as an uncrystallised funds pension lump sum (UFPLS). As this is from the accumulation part of the fund and it was not envisaged as possible before last year, the fund could now be emptied before vesting. This could mean that there are no pension funds left to crystallise, no income and no TFC left to be dealt with by an earmarking order.
Also (although not strictly an issue created by pensions flexibility) historically, the assumption was probably that pension income to earmarked would be “annuity income”. The member could go into drawdown and take no drawdown income or a minimal amount of drawdown. In addition, legislation, post 2015, allows annuity income to reduce meaning that the original intention behind an earmarking order could be frustrated.
Although the earmarking order will be lodged with the provider, the member still owns the plan. This means that the provider can tell the ex-spouse what has happened as they are an interested party but, depending on the wording of the order, it might not be possible to stop the member from accessing the UFPLS. Trying to track cash is always more difficult than tracking a pension fund. Ex-spouses may end up taking legal advice when they believed that their divorce was sorted out many years before.
Post April 2015, the non-pension owning spouse may prefer to have cash rather than a share of a pension fund. Where the member is over 55 this is possible, even if the spouse is much younger, as the right to access the pension fund is linked to the age of the pension policyholder.
The courts may decide that an UPFLS, or a series of UFPLS, should be paid instead of pension sharing. However, that could result in serious tax implications for the member and restrict tax relief on future contributions (because of the Money Purchase Annual Allowance). AVC pots which give flexibility could be requested rather than sharing defined benefit (DB) benefits. Although this may seem to make sense as it would allow access to cash at a time when it is needed, long term this will have an impact on retirement income and becoming a member of a DB scheme (if ex-spouses are allowed to be members’) would be more beneficial in the long term.
Death benefits to consider
Death benefits have changed. Expression of wish forms have always been important but are arguably more important than ever due to the fact that pension death benefits can be passed on through generations. For couples who are separated, this has always been relevant but especially so now. A spouse is technically still a dependant and therefore could end up receiving income benefits where no adult children were mentioned in the expression of wish. The scheme administrator will investigate but it is difficult to guess the intentions of the person who has died.
Spousal Bypass trusts may also be useful in relation to pensions and divorce.
What can you do?
There are many questions but not a great deal of answers at present. There could be legal challenges, further expense, delay and frustration for many. Many solicitors will advise their clients to take financial advice. However, many clients see this as another expense in a costly divorce. If solicitors understand the freedoms then they can help to explain that this may seem like another expense but it could save a great deal of money in the long term.
Source: Clare Moffat – Prudential