Separating couples advised to grasp the financial nettle early on as Divorce Day looms

Strains on relationships can grow during the festive season and send some marriages or civil partnerships to breaking point. Over the years solicitors have noticed an increase in enquiries in early January as people who have been struggling with relationship problems start to think about taking decisive action.

A spike in enquiries regarding divorce often occurs on the first working Monday of the year, which has come to be known rather grimly as Divorce Day - and this year falls on 6 January.

Ben Glassman, Financial Planning Partner and Head of Family & Divorce at leading wealth management firm Evelyn Partners, says: 'Couples should not leave financial issues to the last minute when considering separation or divorce – it’s an aspect of the relationship that can cause some grief in this difficult process, so really it’s worth getting a handle on it right from the start, preferably with the help of some good financial advice.

‘No-Fault legislation enacted in April 2022 means that couples can now divorce on the grounds their marriage has irretrievably broken down, without the need to attribute blame. This less confrontational system can help crucial decisions on the splitting of assets to be made with a bit more clarity and harmony. The new system does not, however, seem to have led to an increase in the number couples taking the divorce route – Family Court statistics show no strong trend, with the most recent quarter revealing a 6 per cent annual drop in divorce applications.[1]

‘Financial pressures can be a complicated dynamic for many couples: money worries can certainly add to the strain on a marriage, but for a few couples they can also weaken the motivation to separate. Some might delay separation because they do not want to incur the costs it entails and don’t like the look of solo life’s financial challenges.

‘The ongoing elevated cost of mortgages, alongside the generalised increase in the cost of living in recent years, has made separation for some couples a trickier financial conundrum than it had been previously. For those who do decide to break up, the fate of the family home and the splitting of financial assets like pensions are often some of the most difficult issues to reach agreement on.'

Splitting assets and financial settlement 

While No Fault might help more couples avoid costly legal exchanges over the separation itself, Glassman warns: 'The temptation is to try and “go DIY” over the whole process, including the financial settlement. This is understandable as people are keen to save on fees wherever possible.

'But the biggest legal bills occur when there is a dispute over the financial settlement, which is a separate matter to the divorce itself, and can often drag on much longer. An agreement over the splitting of assets that is arrived at amicably, and preferably at an early stage, is important if both parties want to minimise stress and expense.

'For many couples to achieve this, advice from a financial planner with experience of divorce will be invaluable, particularly where pensions or other complex matrimonial assets are concerned. The financial implications are for some families more acute amid higher living and borrowing costs, and current economic uncertainty could still affect the jobs market.

'It is the case that living as part of a couple is usually cheaper and more financially secure than living alone, and marriage also carries many tax advantages. Those embarking on life as a single person, particularly if they have been married for many years, can experience something of a financial shock. Nowhere is that more noticeable now than in regard to property, with house prices close to all-time highs and mortgage rates and rental costs remaining higher than they have been in many years.'

In reaching a financial agreement, a court usually considers a 50:50 split as a starting point for a long marriage of more than five years as set out in the Matrimonial Causes Act 1973. This will cover property, pensions, savings and any child maintenance.

The family home and mortgage costs

Glassman says: ‘Property is usually the biggest asset, and if one partner wants to stay in the family home, they will often have to forgo the majority of the other assets such as savings and pensions. One spouse often wants to hang on to the family home when getting divorced, especially where children are involved.

‘But keeping the home doesn’t always make financial sense when taken into context with other assets. A property one lives in doesn’t produce an income and parts of it can’t be sold to meet spending.

‘However, higher mortgage rates have narrowed the options for those who need to borrow to buy a new home, as many divorcees do. Elevated mortgage rates can make finding a solution to the property conundrum for some divorcing couples a lot trickier.

'One spouse remaining in the family home - apart from minimising disruption, particularly where children are involved – has traditionally been the low-cost option as it will avoid some legal, mortgage and property transaction fees.  But the spouse who stays will usually have to find the money to buy the other’s share of equity and, if they can’t draw on other assets to do so, the mortgage rate environment could make it difficult for them to obtain the extra borrowing.

'If there is no option but to sell the home, this could also mean having to pay an early repayment charge if the mortgage was fixed. However, it is often feasible for one party to port an existing fixed mortgage and some lenders even allow couples to split and port a fixed rate loan.

'With rates where they are, a single buyer might find they can afford less than they’d hoped, without moving to a cheaper area – and this will be especially the case for older borrowers who might find lenders less willing to allow monthly costs to be kept down by extending the loan term beyond 20 or 25 years, or into retirement when income is likely to be lower.'

Pensions

Pensions are an area that can either be overlooked or become a source of confusion and dispute at divorce, especially when one spouse has a much greater pension provision than the other. They are often the biggest marital asset after property, and sometimes even the largest, making up 42 per cent of household wealth, according to the ONS.[2]

Many divorcees who don’t take professional advice do not discuss pensions as part of their settlement and this can then lead to costly legal disputes at the eleventh hour as the financial settlement goes in front of a judge, or even after it has been made.

Glassman says: ‘We have seen the average age of a couple getting divorced rising, and alongside pension freedoms introduced in 2015 this has created a greater emphasis in recent years on pension assets in divorce settlements. When a couple are closer to retirement, pension pots are likely to be at their greatest value, and the issue can become contentious when, as is often the case, one spouse (typically the male) holds the majority of pension wealth.

'There are various ways of splitting pension assets, but the important thing is to have it on the radar and make sure pensions are valued properly and an informed agreement is arrived at before the financial settlement – a process that can often require financial advice. Because once the court order is made, it is extremely difficult to alter the settlement.

‘Splitting or sharing pension assets is much more complicated than for cash savings, and will be influenced by the type of pension (is it a defined contribution pot or a defined benefit scheme?), the tax regime that covers pension access and the relative ages of the divorcing couple.

‘The old “earmarking” option is where the non-pension holder receives regular payments – which will cease on the death of the former spouse - but the asset remains firmly in the hands of the pension saver, who will be liable for tax. This option is very rarely used now, and has given way in many cases to splitting or offsetting the pension.

‘When a pension is split the non-pension holder is awarded a share of the asset, which then becomes their own, so they gain control of how they use it, and are no longer tied to the original pension holder.

‘A pension can also be dealt with by offsetting it against other assets, but this can involve often complicated calculations as to the “real” market value of the pension. As such it might be a more usual option among younger couples, who will not have had the time to build up significant pots. Where an individual sees a reduction in their pension pot, it might prove difficult to rebuild, particularly if they have triggered the Money Purchase Annual Allowance.

‘Particular difficulties and confusion can arise over defined benefit pensions in a financial settlement. Valuable DB pensions provide a guaranteed income for life and need careful consideration on how they should be valued and split for matrimonial purposes – not least because different schemes use different valuation calculations.

‘Even when a DB pension has been valued, the question remains as to how it might be shared or offset. These issues have been complicated still further by recent volatility in the bond market, as DB valuations depend in part on gilt yields. As these soared to their highest in 15 years last year, DB valuations have plunged and in some cases nearly halved.’

State pensions are also important, adds Glassman: ‘Women especially often have gaps in their career, which could affect their state pension entitlement. It’s important to obtain a projection, particularly when looking to equalise the pension entitlement of the two spouses. The value of a guaranteed income inflation-linked from age 66 (currently) until death is not to be underestimated.’

Inheritance Tax

‘Over the last few years, defined contribution or money purchase pension pots have typically not formed part of an estate for inheritance tax purposes. If death occurs before age 75 then no tax applies, and if after age 75 then the beneficiary pays Income Tax at their own marginal rate.

‘This has led some people to organise their retirement finances in a way that preserves money held in pensions so that it could be passed on free of IHT, and that could in turn mean very substantial pension assets come into consideration at divorce. In the October 2024 Budget, the Chancellor announced that as of April 2027, pension pots will form part of an estate for inheritance tax purposes.

‘Most types of unused pensions and other pension death benefits will be included in the value of someone’s estate, but that doesn’t mean tax will always be due. There will be exceptions for dependant’s pensions paid from a defined benefit (e.g. final salary) pension scheme, as well as eligible lump sums paid to charities. The changes are subject to a consultation, so nothing is guaranteed yet. However, the consultation is mainly around the complex administration that will likely be required by executors and pension trustees as the overall IHT liability would need to be separated between pension and non-pension assets..

‘This could require a big rethink for those preserving money in pensions for this purpose, and could also lead to changing preferences over how assets are split among the two parties in a divorce. Particularly as one exception to the new pensions IHT rule will be the spousal exemption.

‘Post-divorce it is important to update your Expression of Wishes / Death Benefit Nomination form with each of your pension providers – and sometimes with your employer in the case of death-in-service payments - to ensure benefits are not left to your ex-spouse, unless you wish them to receive it.’

Capital gains tax

Glassman says: ‘Divorce can sometimes require the transfer or disposal of assets and that in turn can have capital gains tax consequences – although the regime has recently changed for separating couples. Transfer of assets between spouses takes place on a “no gain, no loss” basis for CGT purposes, so that no tax is crystallised on the transfer, with the receiving spouse effectively taking the other spouse’s base cost. This rule for spouses used to apply only up to the end of the tax year of permanent separation.

‘Since 6 April 2023 this treatment is available for up to three tax years after the end of the tax-year of separation – or for an unlimited time when the assets are transferred as part of a formal divorce agreement.

'This will provide divorcing couples with more time and flexibility to arrange their financial affairs under the settlement. Changes to the rules around private residential relief also mean that a spouse who retains a share in the family home will be able to claim relief from CGT on any profits they make if the home is sold to a third party – even if they have since bought another home.

'These recent rule changes have made the splitting of assets potentially easier and fairer, but possible CGT pitfalls remain. While the spouse rules work on a “no gain, no loss” basis, they do not extinguish the inherent gain within the asset. In order to understand the real value of their settlement under the divorce, the spouses will therefore need to understand the “net of tax” position.'

Other assets

Savings and investments: In the same way that pensions are usually included in a divorce settlement, so are savings and investments. In Scotland, it is usually only the savings and investments built up during a marriage that matter, whereas the courts in England, Wales and Northern Ireland generally take all of them into account.

Life assurance: Married couples will often have joint life policies in place and after divorce these could be cancelled or assigned to one of the divorcees as part of the settlement. However, this could be an issue if one of the divorcee’s health has suffered and they can’t get replacement life cover. Furthermore, one area that is often is overlooked, is if the ex-spouse has to make maintenance payments for children, until they are financially independent (typically their 18th birthdays or the end of full-time education). These maintenance payments can only be made if the ex-spouse survives so, as part of a divorce settlement, discuss putting in place life cover that would ensure that the payments would continue to be made, even on the ex-spouse’s death.

Business assets: Business owners often don’t realise that their ex – even one who has never been involved with the business – may be entitled to a share of the business on divorce. The court takes into account all assets and is unlikely to make a distinction between business and other assets unless there is legal paperwork to show otherwise. A family court is likely to try hard not to disrupt a business but at times they do decide that the only way to divide assets is to break it up or sell it. This can be devastating and have profound financial implications for business owners, the business itself and potentially. other staff. Divorce can also lead to one party buying out the other.

Wills

Make sure that your Will is updated immediately. If it isn’t changed, the assets could pass to the spouse on death prior to the divorce being granted. You might also want to put in place a Power of Attorney so that decisions can be made in case they become incapacitated prior to the divorce being granted.

The benefits of advice

Glassman concludes: 'Even where couples are truly amicable and wish to ensure their wealth is split in the fairest and most tax-advantageous manner, involving a financial planner can save substantial amounts of money. This is particularly true where there are significant pension assets involved.  The new proposed rules on pensions and Inheritance Tax from 2027 make sound advice even more important.

‘Getting good independent legal advice is always important even if the parties are 'on good terms'. However, we would argue that also having a financial planner involved early in the process is as important. Independent financial assessments can benefit both the divorcing parties, achieve clarity around the real value of the couple's matrimonial estate, and shape the divorce settlement to achieve an optimal outcome for the long-term.’

NOTES

[1] Between July to September 2024 there were 27,003 applications made (74% from sole applicants, 26% from joint applicants) (Table 12b). This was a decrease of 6% from the same quarter in 2023.

Family Court Statistics Quarterly; July to September 2024 - GOV.UK

[2] https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/bulletins/totalwealthingreatbritain/april2018tomarch2020