It’s an unfortunate fact of modern life that many marriages end in separation. Resolving issues relating to divorce and pension sharing is an essential part of any settlement. Even in the most amicable of cases, financial problems tend to focus the mind. Negotiations can become fraught if either side suspects the other of trying to gain an unfair economic advantage.
International divorces can often pose specific challenges. Understanding the legal status of certain assets and the tax treatment relevant to the country in which each partner will live can provide clarity and help avoid potential problems.
Each party to the divorce should have a financial adviser. In certain circumstances, it may be productive for both parties to appoint the same adviser as an independent specialist.
Dividing a Defined Contribution scheme
The valuation of a Defined Contribution (DC) pension scheme is relatively straight-forward. An even split of a DC pension pot ensures fairness, irrespective of market movements. By contrast, in cases where the percentage split weighs in one side’s favour, things can become complicated.
Lawyers tend to leave the date of the pension sharing valuation to as late as possible. The objective is to avoid market corrections. The COVID-19 crisis illustrates the importance of this point. Stock markets have fallen by approximately 25% at the time of writing.
Sharing a Defined Benefit scheme
Sharing a Defined Benefit (DB) scheme is more of a challenge. DB schemes provide a lifetime income in retirement for the member. The Cash Equivalent Transfer Value (CETV) is a monetary expression of the current benefits. The spouse of the pension scheme member often chooses to transfer their part to another pension plan. If the existing member wishes to retain his/her interest in the DB plan, the relative value becomes difficult to compare.
Taking a lump sum settlement now versus a guaranteed income in the future
A financial adviser can provide illustrations and forecasts of the present and future value of a DB scheme to make sure both parties are aware of the available options.
As divorce settlements tend to be lengthy processes, it can help to be flexible on the calculation of the percentage split of assets. CETV’s may increase or decrease dramatically in response to changes in interest rates. Trustees have the right to change the rules regarding benefit calculations, which would alter expected income up or down. Companies that provide DB schemes may find it challenging to maintain contributions in adverse market conditions. COVID-19 has brought this particular issue into focus. The Pensions Regulator has recently issued guidance that allows a level of flexibility for CETV calculations and payments. Trustees can now reduce transfer values, delay payment, or even refuse to provide CETV illustrations.
Taxation, divorce and pension sharing
Taxation is an oft-overlooked issue in international divorces. It is necessary to examine the impact of inheritance tax and capital taxation on any settlement.
The role of the adviser is to outline specific solutions according to the individual’s status. Tax and residency are often the main drivers. The tax treatment of pensions varies in different countries. If one party to the divorce were to live in Portugal, they could benefit from Non-Habitual Residence (NHR) taxation of 10%. Such a tax advantage may seem unfair to the other party who happens to live in France. Taking such factors into account will ensure a fair settlement. It may be that the percentage of entitlements need to be adjusted. Financial advisers can provide information on tax rates and allowances. They can also advise on investment portfolio management and the range of products on offer.
Divorce and pension checklist
The checklist below covers some of the pension-related issues involved in the divorce process:
- Involve a qualified financial adviser with experience in the area of divorce and pension sharing; you should insist that your lawyers appoint one as early as possible. The provision of correct advice in this area will help avoid misunderstandings.
- Both parties to the divorce should try to be flexible in their approach to a settlement.
- Establish the time frame for valuing assets.
- The settlement may include different types of pensions. The scheme differences can impact that valuation of an estate.
- Asset values may change during the divorce process; you should allow for this.
- Be clear about your tax residence status and its implications on your family and the schooling of children.
If you would like some financial advice on divorce and pension sharing please contact us.