Your guide to the tax issues associated with separation & divorce.
With the countdown to the divorce referendum well under way, our tax and private client experts answer some of the more common questions clients have when it comes to the impact separation and divorce has on their tax liabilities. Whatever the outcome of the referendum Irish couples face complex tax rules and issues with regard to separation and divorce. Here we answer some of the more frequent queries we receive.
Question/Topic #6 deals with the complex area of your spouse’s pension. As it is such a broad topic we have grouped together the top questions people have:
Q: My spouse has a large pension. What is my entitlement to a portion of this pension on our separation and a possible future divorce?
A: In the event of a judicial separation or divorce, you may be entitled to a portion of your spouse’s pension. It might surprise you to know that pension assets can be one of the most valuable assets, after the family home, in such proceedings.
Up until recently, people’s awareness of the value of a pension asset in judicial separation/divorce proceedings was limited as the workings of pensions can be difficult to understand and seem complicated. However, as awareness of the value of pensions has increased, we see more and more Pension Adjustment Orders (PAO) issuing.
Q: What is a pension adjustment order?
A: A PAO is a court order which awards a portion of the member’s pension benefits to the non-member spouse or for the benefit of a dependent member of the family. Where you want to make a claim for a portion of your spouse’s pension, you will need to seek specialist advice with regard to applying for a PAO as this is the only legally permitted way that pension benefits can be divided.
Q: I am separating from my husband and we are considering drawing up a separation agreement to deal with his pension. What are my entitlements?
A: A separation agreement which deals with pensions will not be enforceable or binding on the trustees of your husband’s pension fund. The trustees are therefore not obliged to divide the pension asset in any way for your benefit.
However, a Judicial Separation Order or Divorce Order is legally binding on the trustees. Where you are taking into consideration your husband’s pension as an asset providing for you following your separation/divorce, you should seek both tax and legal advice to ensure you are attaining your full entitlements.
Q: What happens to the pension following the PAO? Can I set up my own pension scheme with my portion of the benefit?
A: Following the PAO and the division of the pension by the trustees, you can either leave the pension where it is, in your spouse’s pension scheme, or you can transfer the benefit into your own name.
If you decide to leave the benefit where it is, you will only be entitled to the relevant retirement pension payments at the time your spouse accesses his pension. You do not have the option to take the retirement benefits independently of your spouse. Different retirement options apply depending on the type of pension scheme.
You also have the option of establishing your own pension benefit. This will allow you to take your retirement benefits separate to your spouse, and on your own terms, subject to meeting the conditions of the pension scheme at retirement. The date you can access your retirement benefit will depend on your age and the type of pension.
Q: What factors should I take into consideration when deciding if I should set up my own independent pension?
A: The decision as to whether or not to take a transfer out to a pension arrangement in your own name will be determined by:
- The financial performance of the existing scheme – if the performance is poor, you may wish to take a transfer out
- The funding situation – if it is a defined benefit occupational pension scheme which may be underfunded, you may not wish to transfer your portion as the transfer value may be low compared to if were to leave the pension in place and the pension scheme becomes fully funded again
- The existing scheme may be a self-directed or one-member executive pension plan where the member has control over the investments. Critically, the risk rating of the investments may not match that of yours
Often people prefer to take a transfer and control their own pension pot.
Q: What are my retirement options? Do I have to access my retirement benefit on the same terms as my spouse?
A: You can independently choose how your wish to access your retirement benefits e.g. where your spouse chooses the lump sum and annuity option, you may exercise the lump sum and Approved Retirement Fund option in respect of your share of the pension fund.
Q: Am I entitled to the tax free lump sum of €200,000 as well as my spouse?
A: The retirement lump sum paid to each party under the terms of the PAO is treated as a separate lump sum. This means the tax-free limit of €200,000 applies individually and the extent to which a party is charged the Standard Chargeable Amount (i.e. the portion of the lump sum in excess of €200,000 which is subject to income tax), is based on the amount of the lump sum paid to that party.
Q: What is the maximum pension both myself and my spouse are entitled to where a PAO has been applied?
A: Up to 31 December 2014, the existence of a PAO is treated as never having been made when looking at the pension threshold limits and calculating any Chargeable Excess Tax. This means that your spouse has been assumed to take all the retirement benefits, including your portion, and any chargeable excess tax is their liability alone.
The maximum pension benefit for an individual is €2 million, the Standard Fund Threshold, where no Personal Fund Threshold exists.
However, with effect from 1 January 2015, an amendment was made to the legislation such that any chargeable excess tax arising is apportioned such you and your spouse share the tax charge.
For example, at the date of a Benefit Crystallisation Event (BCE) your spouse has an Executive Pension Plan (EPP) worth €1.5 million. Three years earlier €1 million was transferred to a PRSA on foot of a PAO. At your spouse’s retirement, the capital value of the pension benefits must be calculated as if there was no PAO and as such the current value of your PRSA must be taken into account.
EPP Value……..€1.5 million
PRSA Value…..€1.3 million
Excess is €800,000 (no Personal Fund Threshold) and therefore the CET is €320,000. This will be split pro rata between you and your spouse (i.e. €171,428 tax payable by your spouse and €148,572).
Another point you should be mindful of is further pension contributions by your former spouse to their pension scheme particularly where there is already a chargeable excess. Further contributions will ultimately increase the chargeable excess tax payable.
The tax implications of a PAO on retirement can often come as a shock to the policy holder when they come to retirement. As such, we recommend both tax and investment advice is sought in this area at the time of separation / divorce and not left until retirement as is often the case.
Read the answers to the rest of our tax series on separation, divorce and tax:
Question #3: My spouse and I recently separated. We are currently negotiating a maintenance agreement for the benefit of my spouse and our children. How do we quantify our maintenance needs and agree on an appropriate level of payment?
Question #4: My spouse and I are separating. As she has not worked outside the home it has been agreed that I will provide her with a monthly allowance. How will this maintenance payment be treated for tax purposes?
Question #5: My spouse and I are separating and are concerned about how the family home will be dealt with as part of the proceedings. We may also seek a divorce at some point in the future, how will this impact the family home.
When it comes to tax, the implications of informal separation, formal separation and divorce are different and can be complex. If you have any questions, please contact a member of our tax or private client teams.