The recent finalisation of Bill and Melinda Gates’ divorce after 27 years of marriage reminds us of a curious fact revealed by FTAdviser recently. It explains that while divorce is on the decline overall, within older generations it’s on the increase.

According to the article, while the most recent 10-year data shows divorces fell by 28% in the period between 2005 and 2015, 54% of all divorces were by those aged 60 and above. Aside from the emotional toll this could take at a time in life when people have gained wealth, the financial impacts of ending a marriage cannot be overstated.

This might be something you have seen first-hand as a legal professional. While few divorces are likely to be as financially complicated as the Gates’, it often makes sense for those separating to speak with a financial planner.

One reason for this is pensions. While a pension pot could be one of the most valuable assets within a marriage, research by Legal & General reveals that 24% of people waive their rights to their former spouse’s retirement fund.

This could then deprive them of much needed income in retirement.

That said, there’s another reason why speaking to a financial planner could be advisable for your clients, especially if the value of their pension pots exceeds the Lifetime Allowance (LTA). Read on to discover what the LTA is, why it could expose your client to a 55% tax charge, and how a divorce settlement might negate it.

The LTA is how much pension you’re allowed with tax benefits

While there is no limit to the amount of pension you can have, the LTA is the amount of pension you can build that enjoys tax benefits. In the 2021/22 tax year, it’s £1,073,100.

Any amount over this could be subject to a 25% tax charge if it’s taken as an income, or a 55% charge if you take it as a lump sum. The LTA covers final salary and private pensions.

In the March 2021 Budget, the chancellor froze the LTA until 2026. This could expose your clients to a higher tax liability, as the value of their pension could continue to grow while the LTA remains the same for the next five years.

Furthermore, there has also been speculation in the media that the Treasury may reduce the LTA as it looks to deal with high levels of public spending during the Covid crisis. If this happens, the level at which your clients become liable to the tax charges could reduce significantly.

Divorcing clients may be able to reduce exposure to the LTA charge

One way to share assets during a divorce is to split a pension, and this might allow those facing an LTA charge to reduce or negate it. If both parties agree to use the pension as part of the settlement as opposed to other assets, your client might reduce the value of their pension pot to below the LTA.

Consider the following: The husband of a divorcing couple has a pension pot of £1.5 million, and his wife has a pension valued at £250,000. This means that if the husband accesses any of the £426,900 above the LTA, he’ll face a 25% or 55% tax charge, meaning he could have to pay as much as £234,795 in additional tax.

If, instead, he gives his wife £600,000 of his pension as part of the settlement, he no longer has a pension above the LTA as it’s now worth £900,000. His wife’s pension is now worth £850,000, which means she too does not exceed the LTA.

If your client’s ex-spouse has a large pension, care needs to be taken

If the wife in the above example had a pension pot worth £750,000 before receiving the £600,000 settlement, her pension could then exceed the LTA. This then exposes her to a potential tax charge of up to 55%.

This is because her pension pot is now worth £1.35 million, which is above the 2021/22 limit of £1,073,100.

That said, if the husband were to give £200,000 of his pension in the settlement, this would take the wife’s up to £950,000, meaning she would not be exposed to a potential LTA tax charge.

In addition, the husband would reduce his exposure to the LTA charge and potentially save himself up to £110,000.

Be careful that your client or their ex-spouse doesn’t have pension protection

In some cases, your client may have a protected LTA under the fixed protection rules. This means their LTA could be £1.8 million, £1.5 million or £1.25 million instead of £1,073,100.

If this is the case, it should be treated with extreme care, as rules apply that mean splitting a pension could result in one of the divorcing parties losing the protection. For example, further contributions or certain types of transfer may result in it being lost.

Speaking to a financial planner could help ensure this does not happen. In addition, a planner can confirm whether either has protection they didn’t know about, ensuring it’s not accidentally lost during the pension split.

Get in touch

Care must be taken when using pension splitting to deal with a potential LTA liability. By working with a financial planner you and your clients will have peace of mind that it is done correctly, and will not potentially create a significant tax charge.

If you have clients who are currently divorcing and would like to speak with us about how we can help them with their pensions or wider finances, please contact us on 0800 434 6337.

Please note:

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.