3 things to consider when pension sharing

18 December 2021

What happens when a client receives a pension credit? Jessica List, Pension Technical Manager, Curtis Banks suggests three things for paraplanners to consider

It’s more than 20 years since pension sharing was introduced, and yet recent research from the University of Manchester suggests that only 12% of divorces and dissolutions involve splitting a pension. As such, the effect of receiving a pension credit on the recipient’s retirement plans is not as widely discussed as it could be. Here are three considerations for clients receiving pension credits and reassessing their retirement savings plans.

1) Lifetime allowance (LTA) protection

If the recipient already has LTA protection for their own pension savings, it’s important to remember that receiving a pension credit could affect this protection. Both enhanced and fixed protection can be lost if a person opens a new pension arrangement, except for in specific situations (such as to receive a transfer of their existing benefits, or where a previous scheme is being wound up). As such, if someone with either of these protections receives a pension credit and does not wish to remain in the original scheme, they need to make sure the transfer does not cost them their protection. This may involve transferring the credit into one of their existing pension schemes.

Receiving a pension credit won’t invalidate individual or primary protection. However, the protections also won’t be revaluated, so some or all of the pension credit may end up being over the client’s lifetime allowance and consequently subject to the normal LTA excess charges.

2) Enhancement factors

Pension credit factors are a type of LTA enhancement factor intended to mitigate the effect of a pension credit on the recipient’s LTA entitlement. However, pension credit factors aren’t always available.

To be eligible for a pension credit factor, three conditions must be met:

  • The credit was acquired on or after 6 April 2006 (A-Day) from a registered pension scheme
  • The credit came from crystallised funds
  • The original pension holder had crystallised the funds on or after A-Day.

A different pension credit factor for pre A-Day funds was available until 5 April 2009. HMRC has a late notification process, however, twelve years later there’s likely to be very few exceptional circumstances that HMRC would accept as ‘reasonable excuses’ for not applying sooner.

If a client isn’t eligible, the credit will be tested against their lifetime allowance as normal. If they are likely to incur significant LTA excess charges, this may need to be considered when splitting the pension to begin with.

If you have a new client who received a pension credit in the past, it’s worth remembering that the application window for a pension credit factor is relatively long. Individuals can apply for up to five years from 31 January following the end of the tax year when the pension sharing order took effect. For example, individuals whose pension sharing orders took effect in 2015/16 still have until 31 January 2022 to apply.

Pension credit factors also don’t have any of the planning restrictions associated with some of the other LTA protections. For example, there are no restrictions on accumulating further benefits or joining new pension schemes. Even if the client doesn’t have an immediate LTA issue to mitigate, there shouldn’t be any harm in applying for a pension credit factor just in case.

3) Benefit options

Pension credits from crystallised funds are known as ‘disqualifying pension credits’. The funds are treated as uncrystallised again in the recipient’s hands, except that there’s no PCLS (tax free cash) entitlement. This is extremely easy to overlook, particularly if the credit is held alongside the recipient’s own pension funds, as it might not be obvious in normal paperwork and reports. It could make a huge difference to a person’s retirement plans if they accidentally plan on receiving PCLS from a large disqualifying pension credit.

Such credits can also affect the benefit options available. Uncrystallised funds pension lump sums (UFPLS) are not available from funds attributable to disqualifying pension credits, because it would allow the individual to get the tax free element of a UFPLS in a situation where they wouldn’t be entitled to PCLS. This shouldn’t be a problem if the pension scheme also offers drawdown; otherwise, the client may need to transfer to take benefits. Where a disqualifying pension credit is held in the same scheme as a person’s own uncrystallised funds, the provider must track how much of the pension is attributable to the credit and not make UFPLS payments from this amount.

Pensions are often among a person’s largest assets; often second only to housing wealth. It’s therefore extremely important for them to be taken into account when couples separate their finances during a divorce or dissolution, and for the recipient of the pension credit to think carefully about how the new funds will affect their future plans.

It’s yet another complex area of pensions where financial advice often proves invaluable to an individual’s future success.

Professional Paraplanner