Separating couples urged to address key financial issues early in divorce process

Many couples who have been struggling with relationship problems end up taking decisive action after the pressures of the festive season. Solicitors have traditionally seen a big spike in enquiries regarding separation, and even filings for divorce, on the first working Monday of the year - after couples give up on trying to reconcile differences amid tensions over Christmas and New Year. That means so-called ‘Divorce Day’ falls on 9 January this year.

In 2022, financial stresses largely replaced those of the pandemic and lockdowns, and data has shown a surge in the numbers applying for divorce. Family Court Statistics show that in the second quarter of 2022 (April-June) there was a 22% increase in divorce applications on the same quarter in 2021, while for the third quarter the increase was 8%.[1]

Ben Glassman, Financial Planning Partner and Head of Family & Divorce at leading wealth management firm Evelyn Partners, says: ‘This must be in part due to the legislative change in April. The No-Fault Divorce Bill came into action on 6 April and aims to reduce the potential for conflict amongst divorcing couples in England and Wales by removing the ability to make allegations about the conduct of a spouse and allowing couples to end their marriage jointly.’

No-Fault Divorces

Glassman continues: ‘It now seems very probable that some parties who had split on good terms in 2021, were probably holding off petitioning for divorce and have waited until the legislation came into force before making an application.’

Couples can now divorce on the grounds their marriage has irretrievably broken down – without the need to attribute blame. The move was aimed at enabling less contentious and fractious divorces as before April, adultery, unreasonable behaviour or desertion had to be given as the reason – or two years living apart by agreement, and five years if one partner did not want the other to go.

Glassman says: ‘It is to be hoped that a less confrontational system will allow crucial decisions on things like finances and allocation of assets to be made with more clarity and to achieve more beneficial outcomes. Although as the law change eases the practicality of divorce, more couples in the short term at least might be expected to formalise their separation.’

Splitting assets

Divorce usually involves reaching an agreement on a range of different assets to create a split that both parties can agree on. 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.

Try to be clear-headed about the family home

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 existing assets. A property one lives in doesn’t produce an income and parts can’t be sold to meet spending.

‘Furthermore, 2022 saw the end of ultra-low mortgage rates. What was affordable for a family last year may not be so when one party needs to remortgage. So think about spending as a whole and not just the tenure of the matrimonial home, and if the family home is paramount consider the compromises this might result in.’

Be cognisant of capital gains tax regime change

Transfer of assets between spouses takes place on a ‘no gain, no loss’ basis for CGT purposes. This means that no tax is realised on the transfer, with the receiving spouse effectively taking the other spouse’s base cost. However, this special rule for spouses currently only applies up to the end of the tax year of permanent separation.

‘But under the new legislation, transfers of assets between ex-spouses on or after 6 April 2023 will be available for up to three tax years after the end of the tax-year of separation, or an unlimited time when the assets are transferred as part of a formal divorce agreement. Those currently separating who have a range of property or investment assets to divide might think about deferring their formal separation until after April to take advantage of this more flexible regime.’

The importance of pensions 

A pension can be one of the biggest financial assets that a person has, so it’s important to take them into account when agreeing a divorce settlement – particularly in cases where both spouses are retired. This can be complicated, with outcomes that satisfy both parties sometimes tricky to achieve.

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 is in their 60s, 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 options for how pension assets can be allocated, each with their own pros and cons. The long-standing ‘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.

But this 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 cash 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.

However, there are some circumstances where giving up part of your pension could actually benefit you. For example, reducing your pension could bring you below the lifetime allowance limits, and avoid potential tax charges of up to 55% being incurred in retirement. This could prove beneficial for those who have pension pots in excess of £1m.

Although following divorce, 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.

One final issue to remember is that pension pots don’t typically form part of an estate for inheritance tax purposes.

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 of £10,000 inflation-linked from age 66 (currently) until death is not to be underestimated.’

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 the event that the ex-spouse has to make maintenance payments for children, until they are financially independent (typically their 18th birthdays). 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. 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.

‘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.’

[1] https://www.gov.uk/government/statistics/family-court-statistics-quarterly-july-to-september-2022