Impact of divorce on your pension income
New research shows that getting divorce could slash retirement income by around a sixth.
According to pension firm Prudential, people retiring this year can expect a typical annual income of £19,400, but this falls to £16,300 for anyone who has divorced.
The drop in income is caused by hefty legal fees and the cost of splitting up valuable assets.
Clare Moffat, pensions specialist at Prudential, said: “The financial impact of divorce can be devastating both in the short and longer-term, lasting well into retirement as divorcees experience expected retirement incomes of as much as 16% lower than those who’ve never divorced.”
If you are in the process of getting divorced, it’s vital you know you know your rights when it comes to splitting up your assets in order to minimise the financial impact splitting up will have on your retirement.
The imortance of pension splitting
Mary Waring, managing director of Wealth for Women, says pensions are often one of the most valuable assets, but their importance can be easily overlooked in a break up, when emotions are running high.
“Often pensions aren’t even considered in the [divorce] discussions, but the older you get the bigger the size of your pension, so it may not be that dissimilar to the value of your house," she explains.
“When you are in emotionally a bad place and you just want it all over and done with it is very easy to just think short term without thinking about what the implications are at a later stage in life.”
This guide looks at what you need to know about pensions when going through a divorce or dissolution, the best route to take in a financial settlement, tax implications and when to get advice.
Pensions that can be split
You must disclose all your financial assets when coming to a fair settlement in a divorce or dissolution, including any pensions you have built up or are claiming.
The pension assets that can be divided between you and your ex include:
- Workplace pensions
- Personal pensions
- Additional State Pension
- State Pension top up income
These are considered regardless of their size and when you built them up, even if this was before you were married (unless you live in Scotland).
“Everything needs to be declared – even if it’s a small amount, there has to be full disclosure,” says Waring.
She explains: “If you’ve been married a long time, the general rule is that everything goes into the pot and the solicitors look at how much each party needs.
“If money is a bit tight, all of the pensions have to be taken into account. But if there is more than enough money for both parties to have their needs met, it’s often the case that one will come back and want to ring fence an asset as being a pre-marital asset.”
Options for splitting pensions
Here are the main ways you can choose to split pension assets:
Pension sharing allows you to get a share of up to 100% of any one or more of your ex-partner’s pensions.
It works by either transferring a pension into your name or you joining the existing pension scheme. If you get the pension transferred and you don’t already have your own pension, you must set one up.
Deferred pension sharing
If you are going down the pension sharing route you can defer pension sharing if your ex has already retired and is receiving their pension, but you haven’t and are too young to claim a pension.
This involves making an agreement to share the pension at a later date. This option is not available in Scotland.
Deferred lump sum sharing
You could also go down the deferred lump sum route which means you get a lump sum payments from your ex-partner’s pension when they retire. This option is not available in Scotland.
Pension offsetting allows you to offset the value of any pensions against other assets.
This option can allow you to get the family home in return for your ex-partner keeping their whole pension.
A pension attachment order (known as pension earmarking in Scotland) allows you to get a share of your ex’s pension when it starts getting paid.
The share can be the pension income, the lump sum or both. You’ll need to wait until your ex-partner claims their pension for this.
Get a fresh start. Compare investments you can use for your share of the settlement
Do the courts need to be involved?
You and your ex can agree to offset your pension without a court order.
However, you will need to get the court involved if you choose to make a pension sharing or pension attachment order.
But Waring points out this is not where the expense lies: “The bigger costs will be paying for your legal representatives, and the ongoing discussions rather than actually attending court and getting the document you need.”
What’s the best option?
The simplest route is pension offsetting.
Waring explains: “The absolute simplest way is offset, where you say OK she has the house and he has the pension. It’s the simplest because you don’t need a court order. But it’s not necessarily the best.’
While getting the house in exchange for the pension is a short-term gain, over the long-term you could end up lacking vital income.
Waring warns that pension attachment is rarely a good move either.
‘Unless there are a number of different reasons, the worst way to do it is with pension attachment. That’s because you have no idea when your ex will start drawing the pension, have no control over the assets and how they are invested and the income will be subject to their Income Tax Bracket rather than your own, which is likely to be higher.”
Pension attachment also means you have a lack of control. Your partner may delay drawing their pension and they can choose how to invest it and could decide to be reckless. There is also some emotional baggage to consider too.
“It’s not a clean break, because you have a permanent relationship where you are reliant on money coming over from your ex. It’s not a great set up at all,” says Waring.
Typically, the best option to get a fair settlement is pension sharing.
“With pension sharing the pot becomes yours and so you get away from all these problems of no control over when you are drawing income and no control over how the assets are invested,” says Waring.
“[Pension sharing] allows assets to be transferred into your name so you are in control of them, are subject to tax at your own rate and offers a clean break from the relationship.”
For larger pension pots subject to the lifetime allowance, it might be in your interest to share pension assets over other income as this may reduce your tax liability.
Waring points out: “If the pot is quite large your ex might be subject to a lifetime allowance charge. Then it’s in their interests to split that pot to bring them under the lifetime allowance – so the only person losing out there is the taxman.”
How to find out the value of Defined Contribution pensions
In England, Wales and Northern Ireland your pension is valued at the date of the divorce or dissolution.
To find out the value of these you will need to get the ‘cash equivalent transfer value’. This is the value of your pension were you to move it elsewhere.
It will probably differ from the ‘fund value’ of your pension as it will include charges for transferring.
You can do this if you have a workplace ‘Defined Contribution’ (DC) or personal pension, but not if you have a Defined Benefit pension where the retirement amount is based on your salary (more on this in the following section).
However, if you live in Scotland, only the increase in the value of your pension over the course of the marriage or civil partnership is considered.
You will need to ask your pension provider for a statement that will give you the cash equivalent transfer value for pension at the date of separation and enquire how much of that pension was built up during your marriage or civil partnership.
How to find out the value of Defined Benefit pensions
If you have a defined benefit (DB), or final salary pension, a valuation is more complicated as there isn’t a clear share of money linked to you in the fund so assumptions must be made.
You can ask your scheme administrator if they can provide the ‘cash equivalent transfer value’, but this is unlikely to be a true reflection of the value of the pension.
“When it’s defined benefit pension, there isn’t a pot in that employee’s name, so working out the valuation is open to number of different assumptions being made” explains Waring.
Depending on the size of the pension you might want to consider getting financial advice, as any valuation is open to assumption which could leave you short changed.
“It depends on the size of the pension pot, but I would always recommend, that couples get a specialist actuarial report.”
This can cost up to £2,500, which you can split between you, but Waring says it’s worth it.
“While it’s a chunk of money, dependent on the size of the pension pot, it’s absolutely worth it because that could really influence how much pension you get.”
How to find out the value of your Additional State Pension
The Additional State Pension is an income you build up when you’re employed, while the State Pension top up is a boost to income that you can get by paying a voluntary contribution before 5 April 2017.
In a divorce or dissolution, a court can decide that your Additional State Pension should be shared as part of the financial settlement.
You will need to fill in a BR20 form to provide details of your Additional State Pension and State Pension top up and get a ‘cash equivalent value’
What happens to your State Pension?
If you are entitled to the basic State Pension, this cannot be split or shared if your marriage or civil partnership ends.
But you might be able to claim a better basic State Pension using your ex’s National Insurance Record. You can usually do this if their record during your marriage was better than your own.
However, both you and your ex-partner must reach State Pension age to claim it. If you remarry or enter a civil partnership before you reach State Pension age you will lose this right.
If you are entitled to the new State Pension you won’t be able to take advantage of this rule and you will need 35 qualifying years to get the full amount.
The change to the rules is a problem that will impact mainly women that have taken time out of work to care for children.
“My advice to all women is get a statement before you finalise your divorce settlement and find out what State Pension you are entitled to,” says Waring.
“It will tell you how much you can pay [to build up qualifying years]. I often suggest that payment is made good by the money in the pot before it is split.
“Personally, I don’t think it is unreasonable to say before we start splitting anything can we ring fence what money needs to go into a pot to try and get the wife up to the claim she would have got if she had continued working.”
“The State Pension is linked to the greater of 2.5, price inflation or wage inflation, so it’s really, really attractive. Women, particularly those on a lowish income really ought to be getting the maximum State Pension that they can.”
You can check what State Pension you’re entitled to online. This can show you how many qualifying years you have and how many you will need to get the full new State Pension.
Your new State Pension cannot be shared if you get a divorce or dissolution.
However, if you or your partner have a ‘Protected Payment’, the court may order for it to be shared. This is an additional payment paid on top of the full new State Pension.
For more read this Government guidance on the new State Pension and divorce.
When should you get financial advice to split a pension?
Pensions can be a complicated asset to understand but few know when to seek financial advice.
Waring says it should be done as early as possible for larger pots.
“If your pension assets are very low, then you may well make the decision that the cost of getting advice outweighs the value of the pension.
“When you start looking at £100,000 plus I think you should always be taking advice on it. Because you want to do everything the most tax efficient way and the way that’s going to work best for both parties.
“You can instruct a joint neutral financial advisor, working for both of you. You should do this as early as possible as you want the cost to be included as part of your planning.”
How can you tell everything has been declared?
Unfortunately, there is no sure-fire way to tell if you ex is being honest about all their assets.
“I speak to a lot of clients that are convinced their husband is hiding money, simply because they know the lifestyle he has been leading so it doesn’t stack up compared to what he has declared, but it’s too difficult to prove,” says Waring.
“There are routes you can go where you can get forensic accountants but it’s expensive and you only really want to go down that route if you are pretty sure there is a lot of money to be found somewhere.”
Instead, using some common sense could help you uncover hidden assets.
Waring advises: “Go back and think about what jobs your ex had, when and over what period. This means you can ask the question about if they were on a pension with that company and what happened to it.
“Write it down, divorce can be emotional and you are not going to be thinking very straight, try to piece together as much information as you can about what money was there in the pot.”
Luckily if you uncover evidence after a divorce has been settled you can make a claim.
“Normally when a divorce settlement is approved – it’s over and you can’t change anything. But if there has been incorrect information then you can open a claim,” says Waring.
Splitting pensions after you’ve retired
If you and/or your ex-partner have retired, pension assets may still be split, but the rules are more complicated.
You won’t be able to take a lump sum from your ex-partner’s pension if they are already receiving an income from it – even if your ex has taken one.
Waring explains: “It’s too hard for HMRC to check if they took the 25% sum. So, it’s a blanket rule that if they are already drawing pension income and it goes into a pension share, the other person can’t take a 25% tax-free lump sum.”
The rules for cohabiting couples
If you’re not married or in a civil partnership, your pensions aren’t shared if you separate.
Waring says: “It’s the biggest myth in the world that there is a such a thing as a common law wife.
“There are endless women that have been living with their partner for a long time and probably have children and think they have some form of protection but they have nothing at all.
“The father will always need to care for the children but he doesn’t have to provide any support to his ex [if unmarried].”