February is the month for love, as retailers frequently remind us. For those embarking on love’s young dream, it can be an exciting time.
For others, the plastering of love hearts in every shop window may be a little more painful, given January is the month which sees the most divorce filings.
Divorce is one of the most stressful life events to face, even more so when children are involved. One of the Financial Conduct Authority’s (FCA) big focuses this year is on vulnerable customers, and I would certainly class anyone going through a divorce process, however outwardly amicable it may appear, as at least potentially vulnerable meaning care is needed. This is a time when good financial advice can make a huge difference to people’s lives and help untangle some of the conflicts.
Divorce lawyers are not always up to speed with the latest pension rules. This is very apparent from some of the pension sharing orders that land on our desk which are simply not possible to implement. Having a good financial adviser that knows the common planning pitfalls can help smooth out some of the financial stresses.
When it comes to pensions there are three options available:
- Pension sharing
In a perfect world with plenty of other available assets to use, offsetting would be used, leaving the pension untouched. But if we lived in a perfect world people wouldn’t get divorced.
Earmarking or attachment orders are an out-of-date concept, although many are still around from the time before pension sharing orders became available. They can be hugely problematic, especially where relationships are particularly poor. There is no clean break with earmarking.
The original pension member decides when the pension is taken, and in what form. The ex-spouse gets an entitlement to a percentage of PCLS and/or income payments as specified by the order. When these were drafted no one had heard of pension freedoms.
Members can decide never to take income (thereby denying the ex any funds) and there is a question mark over UFPLS payments as the orders refer to tax-free lump sums and income. Depending on the relationship and sums involved, it may be worth taking these cases back to court to replace the earmarking orders with a pension sharing order so a clean break can be made, and the ex-spouse can control their own funds.
In most new divorce cases with reasonable pension funds involved, pension sharing orders will be the way forward, but there are still pitfalls.
Often the orders try to be too clever. We see requests for specific assets to be transferred or a set monetary amount (only permitted in Scotland), rather than a percentage figure.
On too many occasions we receive orders come through stating that a percentage is to be paid to the ex-spouse, with a total failure to acknowledge the pension is tied up in illiquid investments such as property – with no plan as to how it can be paid out.
It is also worth noting that pension sharing orders can only be applied to “shareable rights”. Most rights held in most types of pension scheme are shareable, however a notable exception is beneficiary’s rights.
Before pension freedoms it would be rare for someone getting divorced to have beneficiary’s rights. However, under the current generous death benefit rules, more and more adult nominees will inherit pensions from their parents (or other family and friends) which could make up a significant chunk of their wealth.
For example, a parent who dies in their late 60s or 70s could have passed on a sizeable pension pot to their children in their 30s or 40s which could easily dwarf their own pension savings.
Last year the average age for divorce in the UK was around 44, so you may well come across divorcing clients with significant assets that cannot be shared.
Qualifying and disqualifying rights
Those of you regularly dealing with pensions on divorce will be aware of the difference between qualifying and disqualifying rights. Disqualifying rights are those paid out to an ex from benefits that are already in payment in the hands of the original member.
These are often seen as less valuable as there is no PCLS entitlement (nor ability to take UFPLS), as the original member has already taken the tax-free element.
Less well known is the fact that taking an income from disqualifying rights doesn’t trigger the MPAA, which could be an important planning consideration.
For example, an older husband and younger wife divorce at age 65 and 55 respectively, where Mr has started taking his benefits so the rights are disqualifying. Ms needs immediate funds but is still working whilst receiving a decent employer contribution, so doesn’t want to restrict her annual allowance.
In this case, receiving disqualifying rights on pension sharing is beneficial for her. In addition, any disqualifying funds paid to the ex that came into payment in the hands of the member after A-day will give the ex an enhancement factor to their lifetime allowance.
Knowing the detail and talking to the member’s pension provider about what can and can’t be done before the order is finalised can make a big difference in smoothing the process for your clients.
Lisa Webster is senior technical consultant at AJ Bell