In many countries, including the UK, there is a tax-free allowance on pensions, also known as a ‘lifetime allowance’. This is the maximum amount of money that you can save into a pension during your lifetime, without having to pay extra tax. This allowance can have significant implications for divorcing couples and a change to the law is now anticipated.
The exact amount of the lifetime allowance can vary depending on the type of pension you have. In the UK, for example, the lifetime allowance for the 2022-2023 tax year is £1,073,100. This means that if the total value of your pension pots exceeds this amount, you will have to pay extra tax on the excess.
It's important to note that this lifetime allowance includes all of your accumulated pension pots, including any workplace pensions, personal pensions, and self-invested personal pensions (SIPPs). If the total value of your pensions exceeds the lifetime allowance, you will have to pay extra tax on the excess.
It is also worth noting that some types of pensions, such as defined benefit pensions, are valued differently for the purpose of the lifetime allowance (and in financial proceedings). This is because the value of these pensions is calculated differently than other types of pensions, which are typically based on the amount of money you've saved and the investment growth. Although defined benefit schemes are now extremely rare in the private sector they are still prevalent in the public sector – with one of the major factors in the new rules being due to many senior doctors accumulating pensions valued above the lifetime allowance and choosing to retire early rather than accumulate pensions above the lifetime allowance.
Pensions on divorce
During a divorce, pensions are often one of the largest matrimonial assets and are always considered as part of the financial settlement. Depending on how pensions are dealt with on your divorce, if you or your spouse have a pension pot that exceeds the lifetime allowance, you may need to pay extra tax on the excess. For example, if you take the excess pension as a lump sum, you'll be charged 55% tax on the amount over the lifetime allowance. If you take the excess as income, you'll be charged 25% tax on top of your regular income tax rate. Particularly since the 2008 economic crash, annuity rates have been relatively low and, therefore, for those on defined contribution schemes the combination of a relatively low lifetime allowance and low annuity rates have been particularly damaging.
One option is to consider a pension sharing order, which allows you to divide the pension pot into two separate pensions, each with its own lifetime allowance. This can help ensure that neither you nor your spouse exceeds the lifetime allowance and incurs extra tax. Tax implications always depend on the specific details of your situation, such as the value of the pensions involved and how they are divided, and specialist advice should be sought. Be aware that pensions should not be looked at in isolation and need to be considered in the terms of the overall financial settlement. There may be a creative solution to reaching an agreement and specialist family law advice should be taken; this could include the parties reaching an agreement where other assets can be “offset” against a potential pension sharing order.
How could the Spring Budget affect my pension if I am going through a divorce? – changes in law
The Spring Budget announced by the Chancellor of the Exchequer on Wednesday (15/03/2023) included the intention to remove the lifetime allowance completely so that nobody will face a lifetime allowance charge from April 2023. This proposal needs to be put into law to be effective, but you should be aware of how this could affect you.
If you have significant pensions (above the current threshold of £1,073,100), and this law is enacted and you are going through a divorce, any proposals as to how pensions should be dealt with should, in theory, be more straightforward. For example, the party with the significant pension(s) could propose to keep all of their pension(s), knowing that it will not be subject to additional tax, and could suggest offsetting the value of their pension against other assets (as necessary) to reach agreement. Previously it may have been more attractive for the person owning pensions valued above the lifetime allowance to enter into a pension sharing order; that may now not be the case.
If you are already going through your divorce and have received a pension report and/or made an offer for settlement based on the current law, you should discuss the change with your solicitor in case waiting for the new law to come into effect will be in your best interests and an updated specialist report may be needed in future.
As always, specialist tax advice and family law advice will need to be sought to cover the individual circumstances, but this is a positive step for family law – providing more flexibility to what divorcing couples can do when considering the division of assets.
How we can help
It is important to work with a qualified financial advisor or tax professional to understand your options and the tax implications of your pension savings during a divorce. At DMH Stallard, we work closely with our financial services counterparts to be able to provide practical and specialist advice. Please get in touch with the Family Team if we can assist you.