Q) I have a married couple client that have decided to end their marriage. They are both concerned about their future pension provision and have asked what will happen to their pension savings upon their divorce. Ben Chaplin, managing director of Taxwise advises:
A) When a married couple divorce or a civil partnership is dissolved, the general approach is that there is to some degree a sharing out of the assets belonging to the former couple.At present if one party to the marriage or partnership has accrued pension rights, then these are viewed by the court as part of the matrimonial assets for disposition on divorce.The term 'divorce' applies similarly to the dissolution of a civil partnership, and 'spouse' applies equally to civil partner.For divorce proceedings which began on and after 1 December 2000, the sharing (or splitting) of pension was possible for the first time and indeed is the preferred route.A pension sharing order requires the pension scheme to ‘split’ the member’s pension so that both parties have separate and independent pensions. The clear advantage is that the former spouse no longer has to wait for the member to take pension benefits but may make his own arrangements. Also the shared pension will not be lost if the former spouse dies before reaching pensionable age.Sharing is undertaken at a set point in time and thereafter the former spouse will not benefit from any further pension contributions or accrual earned, enabling the party whose pension has been shared to rebuild his own pension provision.The pension rights now held by the former spouse may be transferred out to a separate pension arrangement; indeed some schemes insist on former spouses transferring their rights out. The tax implications of pension sharing on divorce is dealt with specially by the tax rules on members’ pension rights.Where the former spouse's rights are retained within the same scheme as the member, the former spouse's rights are known as 'pension credit rights'. The member's reduction in his rights is called a 'pensions debit'. Of course the non-member spouse becomes a member of the scheme from that point onwards, but these terms serve to explain the mechanics of the transfer of rights and benefits.This is the case where the pension scheme in question is a defined benefits scheme. The member and the former spouse to retain those rights within the scheme. The former spouse is in effect treated as a member of the scheme but one who has deferred pension rights.There are a number of tax issues to consider following a pension sharing order. Where the non-member spouse transfers a pension credit into another registered pension scheme, it is not treated as a contribution to that scheme where the pension credit rights derive from another registered pension scheme. No tax relief is due on this transfer of rights.On the other hand, if the pension credit comes from a non-registered pension scheme, then the transfer of this credit into a registered scheme can be treated as a relievable pension contribution. As for all potentially relievable contributions, its value must be tested against the non-member spouse’s taxable income for the tax year in question for it to be relievable. This enables a check of one of the basic rules of contributions to registered pension schemes: an individual cannot obtain tax relief on a pension contribution which exceeds their relevant UK earnings in the tax year in question, although you should take the annual allowance into consideration. Other factors should also be considered including the lifetime allowance and primary protection rules.Ben Chaplin is managing director of Taxwise which are specialist providers of Tax Fee Protection Insurance Schemes to Accountancy Practices. For further information and advice contact Taxwise on 0844 892 2473.
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