Pensions and Divorce - planning for the future

The new tax year brings new opportunities for pension savers. With the abolition of the lifetime allowance (LTA) from April 2024, and a raft of generous measures in the meantime, the future is looking brighter for many.

One group to focus on are those who have, or are soon-to-be, divorced. The breakdown of a relationship is always difficult and deciding how to share assets is often contentious. Here are three key points to think about when guiding your clients through the tricky process of splitting their finances in the 2023/24 tax year and beyond.

1. Fund split matters

Pension sharing orders grant the ex-spouse a share of the member’s pension as a pension credit. This can come from crystallised or uncrystallised funds, or a mixture of the two. The ex-spouse can only take tax-free cash from the part originating from uncrystallised funds – the rest is a ‘disqualifying pension credit’.

As these funds have already been tested against the LTA, the ex-spouse can apply for an enhancement factor, increasing the amount they can crystallise before incurring an LTA charge. But with the removal of this charge from 6 April 2023, there’s now less value in this. What may still hold value is the fact that taking income from a disqualifying pension credit does not trigger the (albeit increased) money purchase annual allowance.

The differing treatment of crystallised funds is a point to consider in advance of any order being granted.

2. Time to rebuild

Those who held enhanced protection or any of the fixed protections before 15 March 2023 can now rebuild their pension without fear of losing their protection. They may also have carry forward available, so could potentially contribute up to £180,000 in 2023/24.

Opening a new pension to receive a pension credit will no longer cause enhanced or any fixed protection to be lost, provided the protection was held before 15 March 2023. This is good news for those who may not have been able to receive a pension credit into their existing pot, such as members of defined benefit schemes.

For individuals with enhanced protection with a protected lump sum, tax-free cash will be the lower of the amount they could have received on 5 April 2023, or at the date they take it. This holds true even following a pension debit, so with contributions now on the table the amount of protected tax-free cash could be restored over time.

3. No change to primary and individual protection

One thing that hasn’t changed is how primary and individual protection are impacted by a pension debit. These protections can’t be revoked, but can be lost if a pension debit causes the deemed value at 5 April 2006 to be reduced below £1.5 million for primary protection, below £1.25 million at 5 April 2014 for individual protection 2014, or below £1 million at 5 April 2016 for individual protection 2016. As these protections allow you to take 25% of the protected amount as a lump sum, losing them could still be costly.