I Must Make Mention Of Your Pension
The Chancellor George Osborne made changes to pensions in his recent budget speech. This could affect you if you are separating, or if you are about to.
The new arrangements, which will come into force in April 2015, will give some people greater access to their pensions. There are also some transitional arrangements in place since last week.
Firstly, these arrangements apply to defined contribution pensions, also referred to as money purchase plans. Under these plans the income a person receives at retirement is not pre-determined. It is based on the assets in the individual retirement plan at the time of retiral. Individuals determine which investments their contributions (and perhaps those of an employer) are invested in from a selection of investment options available within the plan. These are different from defined benefit schemes where the amount of income received at retirement is pre-determined and is usually based on a formula involving the employee’s years of service and earnings. There will therefore be a large number of people in Scotland who will not have the opportunity to participate in the potentially more flexible arrangement referred to below. Those in unfunded pension schemes will remain subject to the current regulations affecting all pensions. This of course may well change in the future, perhaps even by the time the legislation is finalised as there is now a consultation period.
Mr Osborne said that from April next year, people over aged 55 will be able to access their entire pension pot. The existing provision for a 25% tax free lump sum stays, and in addition, there will be scope to withdraw the other 75% – but subject to the pensioner paying their usual rate of income tax on any balance taken (either zero, twenty, forty or forty five per cent). Pensioners will no longer be forced into buying an annuity, although can if they want. For full details go to HM Treasury website at https://www.gov.uk/government/organisations/hm-treasury. It should of course also be borne in mind that when the legislation is actually passed, the final effect may not be as currently anticipated in the recent Budget announcement. Sometimes a watered down result may be what is delivered at the end of the day following consultation. Time will tell.
So for separating or divorcing couples these proposed changes mean that pensions need no longer be looked at solely from the point of view of an income stream in later years, and can now be looked at as a fairly realisable and relatively liquid asset (depending on how old you are). A pension may well be the second biggest asset in a divorce or separation, second to the matrimonial home. It might even be the biggest asset depending on the length of service of the employee (if it is a contributory scheme), the duration of the marriage and obviously, the level of contribution. The importance of the existence of a pension therefore cannot be underestimated when a couple decides to separate. Often the pension value will be offset against the value of the matrimonial home but where this is not favoured, or is perhaps not possible, these new budget changes may do away with necessity for a pension sharing order at all. Instead of perhaps being forced down the route of pension sharing on divorce, there may now be scope to withdraw lump sums from certain pension pots and transfer this money in settlement to a spouse instead. This provides more options for separating couples dealing with their finances if having to consider splitting capital assets. This greater flexibility might generate even better financial solutions for individuals and their families. That must be a good thing.
But what does more scope to be even more creative in relation to financial planning for separating couples mean in practice? We are not authorised by the Law Society to provide financial advice but we have close links with a number of excellent independent financial advisers who are qualified to help with this. An example is shown below of what this may mean in practice for some.
Clearly, anyone who has still to resolve their joint finances following separation should pay particular regard to these proposed legislative changes, and even more so if they are approaching the age of 55. Pensions can be complicated and specialist advice should be sought. Not only do you need robust advice from specialist family lawyers (like all our lawyers here at MTM Specialist Family Lawyers), but you need a good financial expert too. A joint meeting can be really useful to explain all of the options available to you to allow you to make the decision that works best for you.
Lets take 2 entirely fictitious clients, Jane and Steven Collins. Both are over the age of 55 and they are both currently working. Steven earns £100,000 per year whereas Jane, who has only worked part time since having the children some years ago, earns £25,000 per year. They have decided to separate. Both want to act collaboratively and maximise income for the family. Steven chooses to invest the maximum amount into a new pension arrangement, which from April 2014 is £40,000 a year. But as a higher rate tax payer, this is only going to cost him £24,000 in real terms as he enjoys higher rate tax relief – 40% x £40,000 = £16,000 tax relief. If in the context of a divorce, a pension sharing order is granted in Jane’s favour for 100% of Steven’s new pension, then Jane can effectively access this entire pension pot and use her own tax allowances. She would be able to take the first 25% tax free (£10,000). If she took more than this in the first year then this would push her into the higher tax bracket and she would pay 40% rather than 20%. If she took the remaining £30,000 equally over two tax years, the tax paid would stay at 20% (£3000 per year, totalling £6,000) and she would have in her hand another £24,000. Jane would therefore withdraw a total of £34,000 over two tax years but this effectively has only cost Steven £24,000. It has cost Steven £24,000 to give Jane £34,000 cash. Another way to look at it if maximisation of family income was not the main priority is to say it has cost Steven £24,000 to give Jane a pension sharing order of £40,000 on divorce.