Transitional tax-free amount certificates. An overlooked issue in divorce settlements

Pensions are already among the most complex assets to address during divorce proceedings. Recent changes to pension legislation have added another layer of complexity that family lawyers may wish to consider when supporting clients through financial settlements.

The abolition of the lifetime allowance in April 2024 introduced a new framework governing pension tax-free cash entitlements. While the reforms simplified some aspects of pension taxation, they also created potential discrepancies in how historic pension benefits are assessed under the new rules.

For certain individuals, a transitional tax-free amount certificate (TTFAC) may help preserve valuable tax-free pension entitlements. Where pensions form part of divorce negotiations, identifying this issue early can help avoid unintended outcomes and support more accurate settlement discussions.

Before April 2024, pension savings were assessed against the lifetime allowance, which set a limit on the total value of pension benefits an individual could build up without incurring additional tax charges.

The lifetime allowance also influenced the amount of tax-free cash a person could withdraw from their pension. Historically, most people could take up to 25% of their pension benefits tax-free, subject to prevailing allowance limits.

Following the abolition of the lifetime allowance, the government introduced two new limits:

• The lump sum allowance (LSA)

• The lump sum and death benefit allowance (LSDBA)

Under the transitional rules, HMRC broadly converted previous lifetime allowance usage into the new LSA framework. However, the methodology used does not always reflect the amount of tax-free cash an individual actually received.

To address this, pension savers may apply for a transitional tax-free amount certificate.

A TTFAC allows pension scheme members to evidence the actual amount of tax-free cash they received before April 2024.

Without a certificate, HMRC applies a standard transitional calculation. In some circumstances, this may understate a person’s remaining entitlement to tax-free cash under the new regime.

This issue can arise where an individual:

• Accessed pension benefits before April 2024

• Took less than the maximum available tax-free cash

• Holds complex or multiple pension arrangements

• Has defined benefit (final salary) pension schemes

• Holds lifetime allowance protections such as fixed, individual or enhanced protection

For some clients, obtaining a certificate could significantly improve the amount of tax-free cash available to them in future. Tax treatment depends on individual circumstances and is subject to change.

In divorce cases, pension valuations alone may not provide a complete picture of the true value or flexibility of pension assets.

Settlement negotiations often focus on headline pension values, offsetting arrangements or pension sharing orders. However, the future tax treatment of pension benefits can materially affect the real value a client ultimately receives.

This is particularly relevant where one party may rely on pension withdrawals to support liquidity needs following divorce.

For example, a client may have historically crystallised defined benefit pension benefits without taking tax-free cash. Under the standard transitional calculation, HMRC could nevertheless treat part of their new lump sum allowance as already used.

Where a TTFAC is available, that client may be able to restore a substantial portion of future tax-free cash entitlement.

Without identifying this issue early, settlement discussions may proceed based on incomplete assumptions about the value and accessibility of pension assets.

A TTFAC must generally be obtained before certain pension events occur. Depending on the circumstances, pension sharing orders or further benefit crystallisations may limit the opportunity to apply for one later.

For family lawyers, this creates a practical consideration during financial remedy negotiations, particularly in cases involving substantial or complex pension arrangements.

Importantly, applying for a certificate will not always improve a client’s position. In some cases, it may produce a less favourable outcome depending on the structure of existing pension benefits and historic withdrawals.

This reinforces the importance of obtaining specialist advice before decisions are implemented.

While family lawyers are not expected to provide pension tax planning advice, these legislative changes demonstrate the value of involving financial planners at an early stage.

A collaborative approach can help clients better understand:

• The practical implications of pension settlements

• The net value of pension assets after tax

• Future retirement income considerations

• The interaction between pension sharing and wider financial planning

Working alongside family lawyers, we help clients understand the long-term implications of settlement options and navigate technical issues that may otherwise be overlooked.

Divorce settlements are rarely just about dividing assets. They are about helping clients establish long-term financial stability at a time of significant personal change.

Technical pension issues such as TTFAC may appear niche, but they can materially affect financial outcomes if not properly identified and addressed.

Early collaboration between family lawyers and advisers can help clients make more informed decisions, reduce the risk of unintended consequences and support more sustainable financial outcomes over the long term.

To find out more about how we can support your clients, please talk to your usual Evelyn Partners contact.