username

password

Hind Court1 Garden CourtCoram Chambersimage of 4 Paper Buildings logoDNA LegalHarcourt ChambersGarden Courtsite by Zehuti

Using the A Day Rules in Divorce Cases

Peter Heckingbottom of Pearson Jones highlights some of the new pension rules, coming into force on 6 April 2006, that are applicable in divorce cases.

Using the A Day Rules in Divorce Cases

Peter Heckingbottom, Chartered Financial Planner, Pearson Jones plc

There has been considerable press comment about the new pension rules which come into effect on 6 April 2006. Some of this comment has been particularly negative (in relation, for example, to residential property being a permitted investment). However, there are a number of new rules which can be of considerable benefit to family lawyers and their clients in divorce cases. I would like to highlight some of these in this article.

Rebuilding
The advantages available to clients can be demonstrated by the following scenario. Your client is a high earner and has amassed a simple portfolio as follows:

Pensions £1,000,000
Investments £1,000,000

A simple 50/50 share of pensions and investments between wife and husband could be considered. Alternatively the new rules enable a better use of the tax allowance system.

The new pension rules permit any individual to pay an amount up to the total of their earnings into pensions each year (capped at £215,000). A high earning client may therefore prefer that the whole of the pension fund should be passed to the ex-spouse via a Pension Sharing Order. Why? Because the client can rebuild their pension fund from their investments relatively quickly (in this example in 5 years).

In this example, your client grants a PSO to the ex-spouse of 100% of the pension fund and retains all the investments. The client then uses the investments to fund their pension over 5 years at £200,000 per year. After tax relief, the cost to the client of each £200,000 contribution is only £120,000. As a result, your client can rebuild a £1,000,000 pension fund at the cost of £600,000 from their investments.

The net result for your client is that they have £1,000,000 in pensions and £400,000 in investments as opposed to £500,000 of each. Remember the ex-spouse is not disadvantaged as they have a pension credit of £1,000,000.

There are additional opportunities for Private Company directors who may be able to dictate that their company funds their pension at a figure in excess of the annual allowance (there is no restriction on employer contributions). In addition, there is no limit on allowable personal contributions in the year before the pension is drawn (vested). As a result, more funds can be injected into the pension in the final year before retirement.

Whilst on the subject of rebuilding benefits, it is important to remember that logic has now prevailed in the pension debit and credit rules. This issue relates to the overall cap on pension funds (the Lifetime Allowance which starts at £1,500,000 in 2006/7). The new system states that a pension debit will not be counted against the lifetime allowance. In my example, the member with the £1,000,000 debit can, as a result, pay up to £1,500,000 into the scheme without breaching the limits. The member with the credit can only top their scheme up to a total of £1,500,000. This system is far fairer than the old rules.

Fairness
As many divorce lawyers will know, Final Salary Pension schemes can often be one of the most significant assets in a settlement. For an individual close to retirement, a £30,000 per annum pension could be actuarially valued at as much as £1,000,000 (although the CETV may be considerably less than this figure).

One particular problem to consider is where such a scheme permits only external pension sharing orders. The huge problem here is the inequality of a Final Salary Scheme benefit with a Money Purchase Scheme benefit (effectively what is granted to the recipient of the credit).

Again, an example best illustrates the issue. A male age 59 has a final salary pension benefit of £30,000 with a CETV of £600,000. If a PSO of 50% of value is approved, the male would suffer a 50% reduction in income but what would the former wife receive? From her £300,000 external Pension Credit, at age 55 she would be lucky to secure an RPI annuity of £9,000 p.a.

Even worse, if the objective is to achieve equality of income, the calculation is complex but may result in the member suffering a debit of 65% to reduce his income to £10,500 and the 65% credit would buy an annuity to pay a similar amount.

This is a real "Lose – Lose" scenario and resolution is very difficult. Earmarking may assist but is not particularly palatable for either party.

If we now consider the situation where the recipient of the credit does not need immediate income, the disadvantages to the recipient are:

The new Income Drawdown rules, which can continue for life, may be of use. This is important because the individual receiving the external-only credit (in this example) could derive potentially more benefit than the Scheme member with the debit.

The member with the debit has all the guarantees of a Final Salary Scheme but also the hidden potential problems namely:

The member with the credit has some benefits which could include:

Other General Points
There are a number of other significant issues to note from the A Day rules:

Care needs to be taken with pension credits where the recipient already has substantial pension benefits. Breaching the lifetime allowance can generate a tax charge of up to 55%.

Clearly the new pension rules are complex so family lawyers should have develop sensible working relationships with Independent Financial Advisers who are knowledgeable about pension issues and can apply that knowledge to client situations.

_______________________________

Pearson Jones have produced a simple summary of the new rules on an A4 laminate or as a PDF. The summary is available to Family Law Week readers by emailing peter.heckingbottom@pearson-jones.co.uk for a copy. Please state your preference (laminate or PDF).

Peter Heckingbottom FCIB., ASFA.,
Chartered Financial Planner
Investment Director
Pearson Jones plc
Clayton Wood Close
Leeds
LS16 6QE
Telephone 0113 228 0900
Mobile 07984 148718