Divorce and pension protection – what’s the impact?
Divorce is always a sensitive subject. It would be a heartless adviser who would want their clients’ marriages to break down, or distressed new clients arriving on their doorstep, but it is an area where having a good adviser who knows what they’re doing can really make a difference in easing at least the financial headaches. Not to mention the fact that it can be a good line of business.
When it comes to wealthier clients who hold lifetime allowance (LTA) protection the impact of a pension sharing order (PSO) on that protection should be taken into consideration when deciding how to split the assets. Most advisers are unlikely to be dealing with divorce with protection cases on a regular basis and there are a few quirks in the rules that could catch people out.
Taking primary protection first – this cannot be voluntarily given up, however it will be reduced by a pension debit under a PSO, or even lost. Losing the protection can have a more pronounced effect than you might think. Take someone with £3m in their pot at A-Day, so entitled under primary protection to a personal LTA of £3.6m (2 x underpinned LTA of £1.8m). If a pension debit of £1.6m under a PSO is deducted this is deemed to be removed from their fund at A-Day for protection purposes. This gives them an A-Day fund of £1.4m.
When the LTA was introduced it was £1.5m, and to be eligible for primary protection the fund had to be above this level, so the protection is lost completely. The effects are compounded by losing not only the enhancement factor, but also the valuable underpin. The client’s LTA is now the standard £1,030,000, so a £1.6m deduction to the fund loses £2.57m of protection. Definitely one to bear in mind if you’re splitting assets in this scenario, and if possible keep the A-Day value about £1.5m; even if the enhancement factor is tiny, the underpin is not.
You may expect the treatment of individual protection to work in the same way, but it doesn’t. Here the timing of the PSO is taken into account, unlike with primary protection. If the debit is more than 12 months after the protection (6 April 2014 or 6 April 2016 depending on which version is held), then the amount of the debit is reduced by 5% for each full tax year. If primary protection worked like this the blow would be much softer.
Enhanced and fixed protections remain intact, however there is little ability for replacing the funds lost by the debit. If funds are reduced to below the current LTA then it may be worth considering blowing the protection to rebuild.
From the recipient of the pension credit’s point of view, they can get a pension credit if the funds they are receiving have already been tested against the LTA in the hands of the original member.
Another not too common, but potentially very important point for an ex-spouse receiving a credit who holds enhanced or fixed protection themselves, is that transfer to a new arrangement will blow their protection. That isn’t the case if they have an existing scheme that can accept the transfer, but if all the pension savings are in a DB scheme where no transfers-in are permitted, this could be a good reason to try and offset and leave pensions out of the settlement wherever possible.
On the flip side of this, divorce could solve a few LTA issues for those likely to exceed the allowance who aren’t protected. Not sure I’d want to be recommending that to clients though …