Financial Implications of Divorce

Untangling a marriage that is ending in divorce is rarely straightforward.  Dividing chattels and uncomplicated financial assets such as cash and share portfolios may be relatively easy once the emotional obstacles have been overcome.

However, dividing what would usually be the two most valuable assets a couple accumulate during a marriage, i.e. the equity in the former marital home and the parties’ pensions, can be more difficult and requires more detailed analysis.  This article takes a brief look at the key areas to consider and outlines some of the pitfalls.

The Family Home

Under normal circumstances the disposal of one’s main residence is generally exempt from capital gains tax.  However, the family home will cease to be the main residence of the spouse or partner who leaves.

If the property is subsequently disposed of more than three years after one party leaves, part of the gain will be assessable for capital gains tax.  That gain is time apportioned by reference to the period which exceeds the three years mentioned, over the entire period of ownership. For example, Jack and his wife Jill jointly buy the family home in 2000 for £100,000. On separation in 2005 Jack leaves. The property is sold in 2010 for £250,000, Jack will be assessable on: (£150,000 / 2) x 2/10 = £15,000

A tax concession covers such periods when one party leaves the shared home but only where the property is transferred to the occupying spouse or civil partner as part of a financial settlement.  The concession cannot be used where an election has been made by the spouse who moved out, to have a new property treated as their main residence.

The private residence exemption can be preserved on divorce if a Mesher order is made.  A Mesher order allows the family to remain in occupation postponing the sale until a specified event such as the children reaching a certain age or ceasing full time education.  Such an arrangement is treated as a trust and it should be possible to avoid capital gains tax on the subsequent sale so long as that sale is not delayed. With regard to Inheritance Tax no charge should arise on the creation of the Mesher arrangement as transfers for family maintenance are exempt, but exit and decennial charges would apply.

Where property of any type is transferred from one party to the other on separation, neither stamp duty nor stamp duty land tax is payable, even where the acquiring spouse or civil partner takes over a mortgage.

Transfers of Other Assets

The capital gains tax exemption for assets transferred between married couples or civil partners is available only in the year where the couple are still living together at some time during the year.  This means that that transfers of assets pursuant to divorce may give rise to a capital gains tax liability.  

If the assets are qualifying business assets, for example private company shares, the business gifts relief exemption is preserved, provided the transfer is effected before the divorce is finalised.

Care must be taken with second homes and other significant assets that may not be considered high on the list of priorities during the divorce process. If such assets are disposed of some time after the divorce this delay could give rise to a significant tax liability if the parties and their advisers fail to get the timing right.

Pensions

Pensions are not liquid assets and benefits can only be taken in a prescribed way.  The option to Earmark pension benefits and the more flexible and more widely used Pension Sharing Orders are well known. 

Some pensions may be relatively simple to divide with a Pension Sharing Order or Earmarking Order however, the following discusses some of the main issues that need to be considered when trying to divide pensions.

Higher net worth individuals are increasingly making use of Self Invested Personal Pensions (SIPPs) which offer a wider range of investment options including commercial property.  Some (such as partners in law firms or members of barristers’ chambers) club their SIPPs together to purchase their business premises.  Many Small Self Administered Schemes (SSAS) also invest in commercial property.  Although this strategy has advantages, it can be difficult to untangle when one of the parties involved is getting a divorce and the pension needs to be shared.  In this scenario an analysis of all the pension scheme assets, and the share of the ownership between the parties, is vital to identify if a Pension Sharing Order is possible without the need for a forced sale of the property.  Sharing other pension assets or using an offset strategy may be favourable to avoid causing serious implications for the other investors.

The Lifetime Allowance also has to be considered for both parties where there are high pension fund values.  The Lifetime Allowance is currently £1.8m.  The value of money purchase arrangements is simple to calculate, however defined benefit pensions are valued according to the value of the pension income benefits accrued.  This is often an issue for senior and or long-serving individuals who are members of defined benefit occupational pension schemes including public sector pensions.

The issue here is not just for the member but also for the soon to be ex-spouse.  The ex-spouse may be caught by the Lifetime Allowance Charge simply by receiving a Pension Credit.  Whether the individual has Transitional Protection (Primary or Enhanced) is also important.

Different pension trustees will have different rules as to how they deal with Pension Credits.  Some will demand an External Transfer while others will require the ex-spouse to become a Pension Credit Member.  The Armed Forces Pension Scheme has very specific rules and particular care is needed when advising members of this scheme.

The divorcing couple often want to share the marital assets equally, but what is equal when talking about pensions?  Is it the Cash Equivalent Transfer Value (CETV) or is it the pension income that each will receive when the parties each reach their retirement age?  Both approaches have merit.  However, equality of CETV is unlikely to provide equality of pension income.  Women need a larger pension pot to produce the same income as statistically they live longer.  The health of the parties is also a factor that should be considered as this could influence income levels.

Is the CETV a fair value of the benefits accrued?  We still come across CETVs that are not a true reflection of the value of the pension benefits accrued.  It may be sensible to obtain an independent assessment of the true value.  If the pension scheme is in deficit, this will also need to be addressed.

The Chancellor has recently announced that benefits from public sector pension schemes will in future increase in line with CPI rather than RPI.  The impact of this announcement for couples who are divorcing is twofold.  Firstly, many public sector pension schemes have temporarily suspended the quotation of CETVs and some have suspended the implementation of pension sharing orders.  This may temporarily delay proceedings, since, at the time of writing, guidance has not been issued by HMRC.  Secondly, CETVs are likely to drop for members of public sector schemes as a consequence of the switch to CPI from RPI.  There may also be a knock-on effect for some private sector defined benefit occupational pension schemes.

So in summary, the financial implications of a divorce are far reaching and detailed technical knowledge is required in the various specialist areas.  Planning is important and advice should be sought early in the process to minimise the otherwise unforeseen financial implications of divorce.

Further details can be found at the following websites:

http://blogs.ft.com/money-matters/2010/01/11/new-years-resolution-file-for-divorce

http://www.smith.williamson.co.uk/pensions-financial-planning/pensions-and-divorce

 

 

Andrew Yonge, senior consultant, Smith & Williamson

Angela Kellock, tax director, Smith & Williamson

www.smith.williamson.co.uk