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Untangling finances during a divorce is difficult and decisions made at the time can have significant and long-lasting consequences for you and your finances. Often, decisions are made in an emotionally charged environment and the realities of these financial decisions don’t become apparent until much later on.
The role of a financial planner during a divorce
Alongside a solicitor, a financial planner can play a key role during a divorce. People often turn to a financial planner once their divorce settlement is agreed but involving a financial planner early on means that they can help shape the divorce settlement. They help those getting divorced to make the right decisions, reorganise their life and take control of their financial future.
While a solicitor focuses on the legal process of getting divorced, a financial planner will look at the life-long financial implications of decisions made and how they will work in the real world. A financial planner works with the person getting divorced throughout the process and afterwards, making sure that they are confident in their understanding of their financial situation. Financial planners can also help with the burden of decision-making and administration too, by assisting with paperwork and meeting deadlines.
‘Involving a financial planner early on means that they can help shape the divorce settlement.’
Divorce and tax
Divorce usually involves reaching an agreement on a range of different assets to create a split that meets both you and your ex-partner’s needs and makes financial sense. Importantly, it should also have as little impact as possible on your tax position.
Your tax position refers to the amount of income tax and capital gains tax you’ll need to pay. When you’re getting divorced, there is a window of time where a spousal exemption applies and then drops off. Any divorce settlement after a certain date can fall outside this and it can mean that there is no exemption and capital gains tax becomes payable. This can be an extremely complicated area, but a financial planner can help guide you towards an outcome that works for both parties.
Find out more about tax planning
Using cashflow modelling
Following a divorce, there is often a ‘ground rush’ moment. Everything you’ve known for years or even decades has been turned upside down and your head is full of questions. One of those first concerns is often ‘where will I live?’, which can be followed by ‘how will I live?’
By this stage, the longer-term implications of the split are starting to become a priority. A common and understandable question when getting divorced is ‘will I have enough money in the future?’ It’s not an easy question to answer but a financial planner can help by using cashflow modelling to show what your life could look like financially. Cashflow modelling puts a monetary value on what you have now and what you may have in the future, which is then compared against what you are likely to spend over your lifetime to work out if there is a shortfall.
Cashflow modelling takes into account your individual circumstances and can look at different scenarios to help you make the best choices, for example, whether or not it makes financial sense to stay in your former marital home or perhaps if pension offsetting is the best option for you. It is really powerful in helping you in the lead up to a divorce settlement and also afterwards in making the best decisions for your future. Importantly, it can also give you peace of mind at what could be an extremely uncertain period in your life.
Pensions and divorce
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 on a divorce settlement. This is an area where seeking good financial advice at an early stage makes sense.
There are three main ways that pensions are dealt with on divorce:
Pension sharing orders
A pension sharing order will divide up any pensions between the couple who are divorcing. You are given a share of your former husband, wife or civil partner’s pension or vice versa and can decide what to do with it. A pension sharing order provides a clean break.
The amount awarded is called a pension credit and is stated as a percentage of the transfer value of the pension (although in Scotland it can also be stated as an amount). A pension credit can then be transferred into a new or existing pension scheme.
With pension offsetting, the value of a pension is offset against other assets during divorce. As an example, if one party has a substantial pension, pension offsetting could allow them to keep this while their former husband, wife or civil partner retains the marital home.
There are challenges with pension offsetting as it is not easy to split assets fairly and one party could end up with no pension on retirement.
Pension attachment or pension earmarking
Pension earmarking is available in Scotland but has been replaced by pension attachment in England, Wales and Northern Ireland. With pension attachment or earmarking, part or all of the benefits from a pension go to the ex-spouse when the pension pays out. The court instructs the pension or scheme provider to make payments to the former husband, wife or civil partner. With this system, divorcing people don’t get a clean break.
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 whereas the courts in England, Wales and Northern Ireland generally take all of them into account.
Dividing savings and investments is likely to be more straightforward than pensions but there are different tax consequences as well as charges to consider so it is a good idea to get financial advice.
ISAs can only be held in one person’s name so if you are dividing them on divorce they will lose their tax benefits. ISA transfers can only be made to the same individual or a former husband, wife or civil partner in the event of death but not divorce.
Other tax-efficient investments
Other tax-efficient investments such as offshore bonds, Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS) are a complex area of financial planning and during a divorce, they can become even more so because:
- VCTs are similar to ISAs in the fact that the tax benefits are attached to the individual investor. If this ownership is transferred, it gets very complicated
- It is possible to claw back income tax relief on the EIS if it is transferred to a former husband, wife or civil partner. However, this has to be within the first three years of making the investment, regardless of whether or not the transfer is made during the same year of the separation
- How you transfer the segments of an offshore bond is key to mitigating any potential income tax charge
You should always bear in mind that tax rates and reliefs depend on individual circumstances and are subject to change.
Business assets when divorcing
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. A financial planner can help you understand your options and make informed decisions about your business at the time of divorce.
Frequently asked questions about divorce
Should I keep the marital home?
People’s gut reaction is often to hang on to their home when getting divorced, especially where children are involved, but keeping the home doesn’t always make financial sense.
A financial planner will question whether or not keeping your former marital home is the right decision for you and your family. For example, a divorcing person aims to keep the former family home. There is still a significant mortgage attached to the property. After speaking to a financial planner who has run a cashflow modelling exercise, it becomes clear that the cost of the mortgage along with the household bills is equal to their income. Any other expenses would need to be covered by other investments. The capital from these will wind down to almost nothing over the next few years. It could make more financial sense to sell the property and purchase something else that is more affordable, reducing both personal and financial stress.
What happens if there are children involved?
If there are any children involved, in addition to the emotional impact of divorce on their lives, the financial consequences need to be considered too. This often goes beyond deciding on whether or not they should be staying in the former marital home.
Protection against serious illness and death is also important here. Where maintenance is funded from one parent’s income, it is easy to overlook the need to protect the income in case that person dies or becomes ill. Without protection, the surviving parent could face unnecessary risk and could potentially compromise a child’s quality of life.
How can a financial planner help me during my divorce?
Following on from your divorce, you’ll start a new life and it’s likely your finances will need to be restructured to reflect your new way of living. A financial planner will recognise that the key to taking control of your financial future after a divorce is making the right decisions in light of a better understanding of your needs. Under the guidance of a planner, you create a blueprint for your new life. However, this blueprint is not concrete and is subject to change – this is where the true value of an ongoing relationship with a financial planner is really clear.
A financial planner will not only structure your finances and investments through the course of your divorce but also your new life, taking into account changes to inflation, interest rates and your personal circumstances. They will inform you of the consequences so that you are able to make better informed decisions.
You may receive a financial settlement. A financial planner can help you to decide what the best option for your money is, which might involve investing a lump sum. On an ongoing basis, they will continue to review the investment to make sure that it’s performing as it should for you, whether this is producing an income or growing. Please remember though that all investments carry risk and you could get back less than you originally invested.
For some people, this might be the first time they have had to manage their own finances. This could range from making contributions to a pension to paying a council tax bill for the first time. While a financial planner cannot advise on all aspects of budgeting (such as for household bills), they can tell you what you will need to do to stay on track. They can also continue to advise on more complex areas to make sure your money is managed correctly and with confidence.
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