Tax treatment on pensions following the Budget and the impact on divorce settlements

The Chancellor of the Exchequer, Rachel Reeves, yesterday announced Labour’s first post-election budget. It brings a variety of tax changes, including in relation to the tax treatment of pensions.  

The key change from the Budget, in relation to the tax treatment of pensions, is that “from 6 April 2027 most unused pension funds and death benefits will be included within the value of a person’s estate for Inheritance Tax purposes”. A technical consultation has been launched to consider the process required to implement this change for UK-registered pension schemes. 

It is important to remember that the majority of domestic state pensions i.e. UK-registered pension schemes (excluding the basic state pension and new state pension) are capable of being shared between ex-spouses upon divorce. This includes pensions that are in payment. 

There are three ways in which pensions can be divided between ex-spouses when they divorce in England and Wales:

1.They can be offset – so that one party receives non-pension assets in exchange for giving up any rights they may have to the pension assets. This is not without risks, and a Pensions on Divorce Expert (sometimes referred to as a “PODE”) can be instructed to provide an expert view on what an appropriate offsetting amount could be. 

2.They can be shared (known as a Pension Sharing Order) - a transfer from one party’s pension pot (or pots) to the other party. The other party will then hold the pension provision that has been transferred to them in their own pension pot and, depending on the rules of the pension being shared, this can be an existing pension or a new pension set up for that purpose. 

Pension Sharing Orders are the most common way to split a pension on divorce. 

It is important to know that Pension Sharing Orders are always expressed as a percentage, rather than a defined sum, and can be implemented by the pension trustees at any point within a four month window following receipt of (1) the sealed final financial remedy order; (2) the sealed pension sharing annex; (3) the final order of divorce of dissolution; and (4) payment of all outstanding charges requested by the pension scheme. If someone is continuing to pay into a pension that is to be shared then they may wish to cease making payments, provided there is no agreement that they will continue to do so, until the pension sharing order has been implemented.

3.They can be attached to (known as a Pension Attachment Order) – the court can order that one party receives the following provision from the other’s pension pot (or pots):

a. All or a proportion of the income when the pension comes into payment;

b. All or a proportion of the available lump sum when the pension comes into payment; and

c. All or a proportion of the lump sum payable in the event of the death of the party who holds the pension.

The benefit to the receiving party of this provision will need to be considered in light of the new tax changes and potential Inheritance Tax charges on any remaining pension funds in the event of the death of the paying party.

Pension sharing can often form a core part of an ex-spouse’s financial settlement on divorce, and should not be overlooked. Family lawyers will need to take careful note of the Inheritance Tax changes for pensions announced in the Budget when advising on pension sharing on divorce going forward.