If a marriage breaks down, one of the most valuable assets is likely to be a pension – and as time passes the value is likely to increase.
Under British law, if one or both spouses have pension rights, the divorce judge will view them as part of the couple’s financial settlement.
This is when a pre-nuptial agreement comes into play – providing both parties freely entered into the agreement and fully understood how the terms would affect them in the event of a divorce.
Pension options in divorce
The result depends on the type of pension.
If a Qualifying Recognised Overseas Pension Scheme (QROPS) is involved, then the UK court has little or no jurisdiction as the pension will be based in another country.
If the pension is in a UK fund, then the court has several options:
- Offsetting – This means the value of the pension fund is offset against the value of other assets. For instance, one spouse might keep the family home in lieu of a share of the pension fund if both are of a similar value.
- Earmarking – A part of the fund is ring-fenced for a spouse when the pension finally comes into payment. The share is generally declared as a percentage, so the value remains proportionate during the life of the pension.
- Sharing – The pension is split along the line of an agreed share so both spouses have separate and independent pensions.
Earmarking is rarely used by the courts as the option does not allow for a clean financial break.
Tax when a pension is divided up
Pensions and divorce can come with lots of tax issues, depending on which option is followed.
For example, earmarked pensions do not transfer ownership, so the spouse saving the money is charged income tax on any withdrawals, but the spouse receiving the benefit has no tax liability.
Because of this, pension sharing is preferred to earmarking.
But in many cases, the pension member handing over rights to a spouse is at a disadvantage if they want to save more money for retirement.
The divorce settlement can impact tax relief on contributions, their lifetime allowance and pension protections offered by the government over the years.
Pensions and divorce are complicated, and anyone involved in a relationship breakdown should consider taking professional financial advice.