Pensions and divorce

The pension pot should be part of any divorce discussions, says Mark Dobson of Chiene + Tait Financial Planning. (This article first appeared in the Winter 2017/18 edition of our Connect newsletter.)

For many couples, the two most valuable assets they own will be the family home and the combined value of their pension pots. A new study conducted by Scottish Widows has highlighted the limited understanding of how pensions are treated during a divorce and the impact this has on women in retirement.

Where half of women would fight for a share in the property, only 9% claim they want a fair share of pensions. Scottish Widows believe this leads to women missing out on £337m in pension payments every year.

Despite a continual push for equality, the gender pay gap, maternity leave and career breaks restrict the earnings potential for women and this has a direct impact on the size of the pension pot that can be built for retirement in their own name. Yet the study found that almost half of women in Scotland do not understand what happens to pensions during a divorce. Alarmingly, seven out of ten couples do not consider pensions in the divorce proceedings, 21% of women believe each partner keeps the pensions held in their own name and 18% believe the value of the pension is split 50/50.

In reality, pensions should be considered along with all other assets owned by the couple. After the full assessment of the couples’ situation a pension sharing order can be put in place. This could award anywhere between 0% and 100% of benefits from a member to the former spouse.

In Scotland this pension sharing can be achieved either through an official pension sharing order or through a qualifying agreement which does not require a court order. The growth in value of these assets is striking and women should be encouraged to explore their options during divorce to ensure a fair and reasonable settlement.

Giving your bonus to charity – the tax benefits of philanthropy

The philanthropy of high profile sporting and business people often hits the press, most recently with Real Madrid superstar Cristiano Ronaldo donating his Champions League win bonus to charity.  Now hailed as “the most charitable athlete in the world”, Ronaldo’s donation of £456,000 is undoubtedly philanthropic, but pales in comparison to the annual earnings of the highest paid athlete in the world.  With an annual income of $50 million, one could argue that he can afford to be generous with both his winnings and his celebrity endorsement to a charity.

Others in the business world have also made headlines for donating their bonuses to charity including the head of telecom giant Talk Talk. Baroness Dido Harding gave her £220,000 bonus to an autism charity, and the Chief Executive of the 73% publicly-owned Royal Bank of Scotland, Ross McEwan has reportedly set up a charitable trust that would receive half of his £1m role-based allowance every year, over the next five years.

So why do wealthy individuals give to charity? Apart from philanthropy, giving to charity can help reduce a tax bill from both an income tax and Inheritance Tax (IHT) perspectives.

 

Personal Tax

When an individual donates to a charity, the net amount is “grossed up” by HM Revenue and Customs (HMRC).  Therefore if an individual gifts a donation of £80 after tax income to a charity, the charity can claim a further £20 from HMRC making the total amount received by the charity £100.  Higher rate and additional rate taxpayers will also benefit as the gross donation (i.e. £100) is then used to increase their basic rate band e.g. the amount at which 20% tax is paid. In this example, a further £100 would be taxed at 20% instead of 40% giving a saving of £20.  Therefore, the net cost for a £100 donation to a charity for a higher rate taxpayer is only £60.  (£80 donation less £20 of tax saving).

In addition to the above, where the donor has a yearly income over £100,000 their personal allowance will either be restricted or removed altogether.  Depending on the level of the income, gift aid donations can be used to reinstate part or all of the personal allowance. Although the benefits that arise from making charitable donations depend on the individual’s circumstances making gift aid donations can lead to a welcome reduction of income tax, whilst also supporting a favoured charity.

 

Inheritance Tax

Leaving part or all of an estate to charity can reduce or completely eliminate an IHT liability.  If you leave something to charity in your will, it will not count towards the value of your estate and instead will be deemed as leaving a “charitable legacy”.  Individuals can also cut their Inheritance Tax rate on the rest of an estate by 10% (from 40% to 36%), if they leave at least 10% of their “net estate” to a charity.  However, one word of caution, the rules on how to work out what can be given to charity to lower the IHT rate are not straightforward and speaking to your adviser is recommended.

Given the tax advantages of donating to charity, it is obvious that being philanthropic can not only make a difference in the lives of other but can be key to significantly reducing a tax liability.

Tapering of Annual Allowance

From 6 April 2016, individuals who have taxable income greater than £150,000 will have their annual allowance for that year restricted. The standard £40,000 allowance level will reduce by £1 for every £2 of income over £150,000. The maximum reduction will be £30,000, so an individual with taxable income of £210,000 or more will have an annual allowance of £10,000. Two tests are used to determine if the annual allowance is to be reduced – adjusted income and threshold income.

Adjusted income

Adjusted income broadly means the total taxable income from all sources, plus the value of any employer pension contributions.

Example 1

James earns £140,000 and has employer pension contributions of 10% (£14,000) in the 2016/17 tax year so will have an adjusted income of £154,000. This is £4,000 over the £150,000 cap that will reduce the annual allowance by £2,000, from £40,000 to £38,000.

In this case, the employer contributions remain within the tapered annual allowance.

Example 2

Should James also receive a bonus payment of £54,000 during the 2016/17 tax year, the adjusted income would be re-calculated to £208,000. This is £58,000 over the £150,000 cap which will reduce his annual allowance by £29,000, from £40,000 to £11,000.

In this case, the pension contributions of £14,000 are over the tapered annual allowance of £11,000 and if carry forward is not available then an annual allowance tax charge is required to be paid (in this instance at the full rate of 45%, thus totalling £1,350).

Threshold income

To ensure pension savings over £40,000 (using carry forward) do not affect lower paid workers, a second income definition is used – threshold income.

This test considers total taxable income less gross pension contributions paid under the relief at source system. Any individual with threshold income under £110,000 is able to retain the full £40,000 annual allowance.

Example 3

Lisa draws an income of £105,000 in the 2016/17 tax year. Her business had a successful year and using available carry forward an employer pension contribution of £60,000 is made. The adjusted income would be calculated as £165,000 which would normally reduce her annual allowance by £7,500, from £40,000 to £32,500.

However, the threshold income calculation can deduct the £60,000 pension contribution from the adjusted income calculation, resulting in a threshold income of £105,000 which is below the £110,000 limit. This allows for the full £40,000 annual allowance to be retained.

The ability to carry forward three years of unused allowance will remain unaffected, will not be subject to post-dated tapering and, therefore, is a valuable pension contribution tool. Once carry forward is exhausted, consideration for alternative investment vehicles may be required.