You don’t have to look very far at the moment to find news stories about how divorce and dissolution rates are expected to rise during and after lockdown.
Law firms across the country are reporting surges of enquiries, with one firm local to us in Suffolk reporting a 1,233% increase in the traffic to the divorce, separation, mediation, and family law information on their website.
Where these divorces and dissolutions do go ahead, pensions are likely to be considered when the couples come to split their assets.
In many cases, a pension sharing order will be the simplest course of action, which involves an agreed amount being transferred from one person’s pension (as a pension debit) to the other’s (as a pension credit).
However, it’s important that parties on both sides of a pension sharing order consider the wider effects on their retirement planning, as pension debits and credits can play havoc with lifetime allowance (LTA) planning and lifetime allowance protection. Here’s what to look out for.
Pension credit factors
In all cases, clients who receive a pension credit will need to consider that the funds become theirs, and will, therefore, be tested against their lifetime allowance. For some, this will mean that lifetime allowance planning becomes a consideration for the first time.
When a pension credit comes from funds which the ex-partner had already crystallised, the client may be able to apply for a pension credit factor: a form of protection which increases the client’s lifetime allowance to take account of the pension credit.
Pension credit factors are available where the funds forming the pension credit were crystallised on or after 6 April 2006 (A-Day), and where the pension credit acquired on or after A-Day. There was another form of pension credit factor for pre-A-Day funds, but those normally had to be applied for by April 2009.
Clients can apply for pension credit factors regardless of other protection types they might already hold. Pension credit factors also don’t come with wider conditions or restraints (such as requiring the client to stop contributing), so can be worth applying for even if the lifetime allowance isn’t an immediate concern.
Clients who lose funds to a pension debit will have their primary protection factors revalued. The value of the pension debit is deducted from the value of the pension rights from 5 April 2006 (which would have been used to calculate the original protection factor), and a new factor is calculated.
If the pension debit is large enough, primary protection could be lost altogether. The client will be subject to their new primary protection or the standard lifetime allowance (as the case may be) for all future benefit crystallisation events, but previous crystallisations are unaffected.
Clients with primary protection who receive a pension credit won’t lose their primary protection, but it isn’t reassessed either.
A pension debit doesn’t directly affect enhanced protection; however, clients in this position may struggle to rebuild any lost funds, as accruing new pension benefits will normally invalidate enhanced protection.
Clients with enhanced protection who receive a pension credit will need to be careful to ensure they don’t invalidate the protection. There are strict rules about opening new pension arrangements, and about the types of transfer which can occur without losing the protection. Often, the pension credit will need to be moved into one of the client’s existing pension arrangements.
Clients losing funds to a pension debit while holding one of the forms of fixed protection will be in a similar position as those with enhanced protection: the pension debit won’t invalidate the protection, but accruing new benefits to rebuild the lost funds will.
Clients with fixed protection receiving a pension credit will also be affected in the same way as those with enhanced protection: they will need to take care to ensure that they don’t invalidate their protection while receiving the credit.
Pension debits affect a client’s ‘relevant amount’, which is the value of their pension rights on 5 April 2014 or 2016 (depending on the protection type) used to calculate their protected lifetime allowance.
First, the value of the pension debit is revalued: it is reduced by 5% for each complete tax year between the protection taking effect and the day the pension debit takes effect. That amount is then deducted from the client’s relevant amount, and their individual protection amount is either reduced or lost accordingly for future benefit crystallisation events.
Receiving pension credits doesn’t invalidate individual protection, but doesn’t cause the protection to be reassessed either.
The lifetime allowance is probably the last thing on a person’s mind when going through a divorce or dissolution. However, losing protection, or missing the opportunity to apply for it, could have enormous consequences for a person’s retirement planning, and is well worth considering at the time.
Jessica List pension technical manager at Curtis Banks