The 8th January has been dubbed ‘Divorce Day’ in the UK because of a typical rise in the number of couples seeking to end their marriages following the festive period.
According to law firms, divorce proceedings often begin on the first working Monday of the year, which falls on the 8 January this year. However, couples who make the decision to divorce can face considerable financial challenges, Evelyn Partners has warned.
A two-year bout of high inflation, soaring mortgage rates and economic uncertainty that could still affect the jobs and housing markets has made the financial implications of divorce particularly acute, says Ben Glassman, head of family and divorce at the firm.
Glassman says: “It is the case that living as part of a couple is usually cheaper and more financially secure than living alone, and marriage also carries many tax advantages. Those embarking on life as a single person, particularly if they have been married for many years, can experience something of a financial shock. Nowhere is that more noticeable now than in regard to property, with house prices close to all-time highs and mortgage rates and rental costs higher than they have been in many years.”
In reaching a financial agreement, a court usually considers a 50:50 split as a starting point for a marriage of more than five years. 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.
However, Glassman says that keeping the home does not always make financial sense when taken into context with other existing assets, because it is unable to produce an income and parts cannot be sold to meet spending. But, higher mortgage rates have narrowed the options for those who need to borrow to buy a new home, which has made finding a solution to the property conundrum for some divorcing couples a lot more challenging.
Glassman explains: “One spouse remaining in the family home, apart from minimising disruption, particularly where children are involved, has traditionally been the low-cost option as it will avoid some legal, mortgage and property transaction fees.
“But the spouse who stays will usually have to find the money to buy the other’s share of equity and, if they can’t draw on other assets to do so, the new interest rate environment could make it difficult for them to obtain the extra borrowing. Conversely, the shared mortgage could be on a low-rate fixed deal with years to go, and the spouse who departs might feel aggrieved at having to borrow at inflated rates to fund their new home.”
For those who opt to sell the home, a weakening property market could mean they must accept a lower offer than expected and potentially have to pay an early repayment charge if the mortgage was fixed. Each partner will then face the task of securing a new mortgage at elevated rates to buy their respective new homes.
Couples choosing to divorce will also need to give thought to pensions, which are often the biggest marital asset after property. According to the Office for National Statistics, pensions make up 42% of household wealth.
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 ways of splitting pension assets, but the important thing is to have it on the radar and make sure pensions are valued properly and an informed agreement is arrived at before the financial settlement – a process that can often require financial advice. Because once the court order is made, it is extremely difficult to alter the settlement.”
Splitting or sharing pension assets will be influenced by the type of pension, the tax regime that covers pension access and the relative ages of the divorcing couple. The long-standing ‘earmarking’ option is where the non-pension holder receives regular payments but the asset remains firmly in the hands of the pension saver who will be liable for tax. This approach, says Glassman, has given rise to splitting or offsetting the pension. However, where an individual sees a reduction in their pension pot, it can be difficult to rebuild, particularly if they have triggered the Money Purchase Annual Allowance.
Glassman says couples should also consider state pensions. Women in particular often have gaps in their career which can affect their state pension entitlement.
Glassman says: “It’s important to obtain a projection, particularly when looking to equalize the pension entitlement of the two spouses. The value of a guaranteed income of £10,000 inflation-linked from age 66 until death is not to be underestimated.”
In addition, divorce can sometimes require the transfer or disposal of assets and this can have capital gains tax consequences, although the regime has recently changed for separating couples. Transfer of assets between spouses takes place on a ‘no gain, no loss’ basis for CGT purposes so that no tax is crystallised on the transfer, with the receiving spouse effectively taking the other spouses’ base cost. While this rule for spouses used to apply only up to the end of the tax year of permanent separation, new rules introduced in April 2023 mean this treatment is available for up to three tax years after the end of the tax-year separation or for an unlimited time when the assets are transferred as part of a formal divorce agreement.
Glassman says: “These recent rule changes have made the splitting of assets potentially easier and fairer, but possible CGT pitfalls remain. While the spouse rules work on a “no gain, no loss” basis, they do not extinguish the inherent gain within the asset. In order to understand the real value of their settlement under the divorce, the spouses will therefore need to understand the ‘net of tax’ position.”
Divorcing couples will also need to consider the financial implications for life insurance, with married couples often having joint life policies in place. These could be cancelled or assigned to one divorcee as part of the settlement but could run into issues if one of the divorcee’s health has suffered and they can’t get replacement life cover.
Similarly, business owners will need to consider the impact of divorce on their business assets. The courts take into account all assets and are unlikely to make a distinction between business and other assets unless there is legal paperwork to show otherwise.
While many couples choose to “go DIY” to avoid hefty legal fees, a dispute over the financial settlement, which is a separate matter to the divorce itself, can often drag on much longer and lead to large legal bills, warns Glassman.
He adds: “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.”
