Sarah Keily in our family team recently helped answer a reader’s query for personal finance publication This is Money.
My ex-husband contacted me recently because he intends to take advantage of the change in UK pension law, to allow him to withdraw 25 per cent of his pension in a lump sum (tax-free) and then receive the balance in monthly or yearly payments.
As we have a UK divorce order from 2002 which ordered that I should receive 30 per cent of his company pension, does this now mean that I am entitled only to 30 per cent of the 25 per cent he intends to withdraw, and that he then gets to keep the rest as regular payments?
In this case it would appear that I would not be getting 30 per cent of the 100 per cent actual pension, as envisaged by the court at that time - is this correct?
Also, as we both now live abroad, if we then take the money outside UK, do we pay tax locally on it, despite the sum being tax-free in UK?
Tanya Jefferies, of This is Money, replies: You are wise to look into this because the pension freedom reforms five years ago do potentially affect divorce settlements, depending on what kind of agreement you reached at the time.
We asked a lawyer to explain what kind of pension order you are likely to have, what impact subsequent pension changes might have, and what you should do next.
She suggests you take immediate action to ensure your rights are protected.
Neither she nor This is Money can answer your question on tax, as we do not know where you and your husband live overseas.
You should ask your local tax authority, and if necessary consult an accountant as well about the rules in the country where you reside.
Sarah Keily, a partner in the family team at law firm Thomson Snell & Passmore, replies:
You say that you have an order that you should receive 30 per cent of your ex-husband’s company pension.
It is not clear from this whether you have a pension sharing order or a pension attachment order - previously known as a pension earmarking order - although it sounds likely to be the latter.
Pension sharing is the method by which an existing pension arrangement is split and divided between the parties following divorce proceedings.
A pension sharing order transfers a part or all of a pension from one party to the other, giving the recipient a separate pension fund in their own name that can be invested in the same scheme or in another external scheme, depending on the relevant scheme rules.
A pension attachment order requires the trustees of a pension arrangement to pay a percentage of the following assets to one of the parties when a pension becomes payable to the other party.
- Pension income, and/or
- Pension commutable lump sum, and/or
- Death benefits.
In this way, the recipient 'attaches' to the existing pension arrangement
It sounds like you have a pension attachment order, as you did not receive any benefit from your ex-husband’s pension at the time of the divorce.
This means that when your ex-husband starts drawing his pension, you should receive 30 per cent of whatever sum he receives.
How does 'pension freedom' affect divorce settlements?
Prior to April 2015, people were able to take 25 per cent of their pension as a tax free lump sum on retirement.
Most were required to use the remaining 75 per cent to purchase an annuity to provide them with an income for the remainder of their life, though there were exceptions for better off people who were allowed to invest it.
What is pension freedom?
Pension freedom reforms gave over-55s greater power over how they spend, save or invest their retirement pots.
Key changes from April 2015 included removing the need to buy an annuity to provide income until you die, giving access to invest-and-drawdown schemes previously restricted to wealthier savers, and the axing of a 55 per cent 'death tax' on pension pots left invested.
The changes apply to people with 'defined contribution' or 'money purchase' pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement.
They don't apply to those with more generous gold-plated final salary or 'defined benefit' pensions which provide a guaranteed income after retirement.
However, those still saving into such schemes can transfer to DC schemes, provided they get financial advice if their pot is worth £30,000-plus.
However, pension freedom reforms were launched in April 2015 which allow anyone aged 55 and over to take the whole amount of their pension fund as a lump sum.
They pay no tax on the first 25 per cent and have the rest taxed as if it were a salary at their income tax rate, with no requirement to purchase an annuity.
In practice, most people take the 25 per cent tax-free lump, invest the rest in financial markets and draw an income from it over time, to avoid a punitive income tax bill if they withdrew it all at once.
However, there is a risk that the pension freedom reforms will result in unfairness to the recipients of pension attachment orders as the pension member can effectively withdraw their entire pension before the order comes into effect.
The Pensions Advisory Group of legal experts issued a useful handbook called ‘A Guide to the Treatment of Pensions on Divorce’ in July 2019.
In that guide they urged individuals with pension attachment orders made prior to the pension freedom reforms to take legal advice to make sure that the order still provides for what was originally intended.
What should you do now?
It sounds like your ex-husband intends to take 25 per cent of the pension fund as a tax free lump sum, and then either buy an annuity with or invest the remaining 75 per cent.
Whether you are entitled to receive 30 per cent of the tax free lump sum and 30 per cent of the income paid out through an annuity or from investments will depend on the wording of the pension attachment order.
Therefore, you should take the following action swiftly.
1. You should take legal advice about this and ask your lawyer to check the wording of the pension attachment order and make sure that you will still receive what the court originally envisaged for you in 2002.
If you will not, your lawyer will advise you on the steps you can take to protect your position, including applying to vary the original order in respect of pensions to ensure that you receive what was originally intended.
The court can also order the pension trustees not to make any payments out of your ex-husband's fund until the issue is resolved.
2. You must also check that the trustees of your ex-husband’s pension scheme have a copy of the order and are aware of your interest and entitlement.
It would be sensible to contact them immediately and provide them with a copy of the pension attachment order.
3. As you and your ex-husband are both living abroad, there may be a risk that he could consider transferring the whole of his pension fund into an overseas pension, such as a Qualifying Recognised Overseas Pension Scheme (QROPS).
If that happens, the pension attachment order would become ineffective, as it cannot attach to such a scheme.
This is another reason to make sure that the pension trustees are aware of your interest in the fund and that they have received a copy of the court order.
This article original appeared in This is Money