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State pension: why it will matter on divorce

May 6, 2013 in Financial planning, Pensions by Alan Larkin | 2 comments

Sam Jermy Family Law Financial Planning state pension on divorce

GUEST BLOG: Sam Jermy of Family Law Financial Planning

 

 

State Pension Reform

In January of this year, a radical reform of the state pension was unveiled. The proposed reforms will affect millions, many of whom will be worse off under the new scheme.

Changes to occupational and public sector pension schemes often evoke significant backlash and protest. In some cases it has led to national strikes. The response to the proposed state pension reform in contrast has been pretty subdued. One could even say non-existent. So why such a passive response to significant reform? Well, I have a theory:

    1. The majority of us have absolutely no idea what our state pension is worth to us or when it will be paid.
    2. A common perception is that the state pension is likely to be worth very little to us.
    3. For many, retirement seems a long way off. We have enough to worry about in the present

I believe these factors go a long way to explain why pensions and more specifically the state pension often receive little focus in divorce proceedings.

Let’s actually consider what the state pension could be worth to you. Under the new scheme, a full state pension entitlement would be worth £144 in today’s money. If we assume that these payments retain their inflation proofing and consider that they could be paid for say 35 years. On these assumptions, a total of £262,080 would be paid in today’s terms. When viewed in this way, the dull old state pension suddenly seems a little more interesting.

State pension proposals

The Department for Work & Pensions proposal document, “The single-tier pension: a simple foundation for saving”, lays out the detail of the reforms. It is a joyful read at 108 pages. I have summarised the key points below.

      • The reforms will not take effect until April 2017 at the earliest.
      • For those that reach state pension age before implementation of the reforms, they will retain their existing entitlements and benefits.
      • The existing complicated structure of a basic and various additional state pension entitlements will be replaced with a single tier pension
      • For those reaching state pension age after implementation of the reforms, their existing National Insurance records will be translated into a “Foundation Amount”. This Foundation Amount in effect provides a level of entitlement to the new single tier pension. Further entitlement can be built up in the future.
      • The full new single tier state pension is likely to be £144 per week. This amount is likely to be uprated by the highest of growth in prices, average earnings or 2.5%.
      • Individuals will need 35 qualifying years of National Insurance Contributions or credits for the full pension amount.
      • Individuals will require a minimum of 7-10 years to start to qualify for a proportion of state pension.
      • There will be no facility to inherit state pension rights or derive them from a spouse or civil partner (subject to transitional provisions).

The devil in the state pension detail

As usual the devil is in the detail. For the purposes of this post, I would like to focus in on the implications of the reforms for divorce.

The present system facilitates the following:

  • If a person on divorce does not have a full National Insurance contribution record up until that time (currently 30 years), they may apply to substitute the National Insurance record of their former spouse for their own record in relation to all tax years during their working life. They can do so up to the end of the tax year in which the marriage ended or the end of the tax year before they reach State Pension Age (SPA), whichever comes first. This process is referred to as Pension Substitution and is a benefit which needs to be claimed rather than being granted automatically. If the ex spouse subsequently remarries they will lose the benefit of any Pension Substitution top up, unless the remarriage occurs after their State Pension has already come into payment.
  • Any additional state pension entitlement can be taken into account as a financial asset on divorce. This means that part of the value of any additional state pension you have earned could be shared with a former husband, wife or civil partner.

Following the implementation of the proposed reforms, the situation fundamentally changes.

  • It will not be possible to claim pension substitution
  • It will not be possible to share any additional state pension entitlement

The proposal document states:

“The single-tier pension has been designed to ensure that the large majority of individuals will be able to get the full rate in their own right. In steady state, there will be no rationale for allowing people to inherit or derive state pension income based on the National Insurance record of their spouse or civil partner”.

What now for pension sharing orders?

So what does this mean for those divorcing now or in the future? In my mind the following points are relevant.

  • Any pension sharing orders already in place prior to implementation will be honoured. This places a deadline (likely to be April 2017) on getting additional state pension sharing orders in place.
  • In order to qualify for a full state pension following implementation of reforms, it will be necessary to have 35 years of contribution history/credit in your own right
  • Post implementation, divorce lawyers will need to examine the disparity between the state pension entitlement of a husband and wife and consider how this should be taken into account. The disparity may become a more significant factor in the absence of pension substitution
  • It is vital for people to quantify their state pension entitlement and the contribution this makes to their future financial security

A professional financial planner will be able to incorporate an individual’s state pension benefits into a cash flow forecast. By combining state pension benefits with other income and assets, a cash flow forecast can provide important insight into future financial security and needs.

In the absence of additional state pension sharing and substitution, it will become more important than ever to consider future income needs in retirement.

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Sam Jermy works for Family Law Financial Planning Ltd which is an appointed representative of North Laine Financial Management Ltd which is authorised and regulated by the Financial Conduct Authority. North Laine Financial Management Ltd’s FCA Register number is 446522.  The views expressed in this guest post are Sam’s own. Please contact your own independent financial adviser or family lawyer if you believe the issues raised by Sam impact upon you. Alternatively, please post a comment or query below and Sam will do his best to respond.

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Divorce financial planning and interest only mortgages

May 2, 2013 in Financial planning, Uncategorized by Alan Larkin | No comments

Divorce financial planning and interest only mortgages

A bridge too far? Interest only mortgages

There is a worrying report from the Financial Conduct Authority (FCA) about interest only mortgages.  With an interest only mortgage you pay off the interest on the loan each month but nothing towards the capital you have borrowed at the end of the term.  If you do not have a savings plan to meet this capital payment at the end of the term, which could be at the point of retirement, you will be in trouble.  The report refers to some 2.6 million interest only mortgages coming to maturity between now and 2040.

The aspect of the report that struck me, is as follows:

More worryingly, it found some people were “underestimating the problem”: 37% of those quizzed reported a definite or possible shortfall between what they will have to pay the lender when their mortgage term ends, and what their savings, investments or other strategy will deliver. And borrowers who were able to give a figure believed their shortfall would be, on average, £22,000. But when financial modelling was carried out, the proportion who may not have enough money to pay off the loan jumped to 48%, and the average shortfall was “considerably higher”, at £71,850. That sum is approaching half the average £162,000 house price in England and Wales.

An article on the FCA’s report can be read in The Independent.

What now for interest only mortgages?

As a family lawyer specialising in financial settlement I want to know how my advice today will affect my clients in 10, 15 or 20 years’  time. I normally take a dim view of the opposing lawyer who suggests that my client should consider interest only mortgages when I know she will not be able to build up savings in the future on her present or predicted income.  As readers of my blog will know, I think that ‘reality-testing’ any proposals for settlement on divorce or separation is crucial.  One way to do this is to make sure that financial planning advice has been obtained.  The financial modelling referred to in the FCA report is precisely the advice I import for my clients so they know exactly where they will stand in the future if they accept a settlement proposal.

It does not mean that interest only mortgages would not be right in some situations, but I fail to see how a client can make an informed decision today if they are not being assisted to look at their financial health tomorrow.

If you do find yourself facing a shortfall then consider some of the options in this useful article in The Guardian.

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Pension planning on divorce

April 23, 2013 in Financial planning, Legal services, Pensions by Alan Larkin | No comments

pension planning on divorce needs financial planning

Divorce and pension planning

Pension planning on divorce is crucial.  After the matrimonial home, the asset of greatest value accrued during any marriage is likely to be the pension pot.

One of the challenges for a family lawyer is to explain to a client, especially a wife, why she should not ignore her lack of pension provision during divorce proceedings. Understandably, most clients’ priority is the welfare of the kids.  Or keeping the family home.  But once a divorce is obtained, it is imperative that the family lawyer has imported expert advice for pension planning on divorce for the client.  There are three main outcomes to this pension planning:

  • Pension offsetting.  This is where the pensions are valued but are not subjected to pension sharing or pension attachment.  So, for example, the wife may decide to keep a cash investment saved elsewhere during the marriage but leave the husband’s pension untouched.
  • Pension sharing order.  This is where a specific pension fund, or a number of funds, are split, along percentage lines.  So for example, the husband’s pension fund with Many a Muckle Assurance Ltd worth £100,000, is split so as to give the Wife 40% of the fund value.  The details are drawn up on a pension sharing annex and attached to the family court’s financial order on divorce.  The pension is split reasonably quickly, once the pension trustees have had time to implement the order (they have 4 months, in fact).  You can’t actually get your hands on the money, of course, it is hived off to create your own pension fund ready for your retirement.
  • Pension attachment order.  The pension fund is not split.  Instead an order specifies that a proportion of the pension fund’s benefit, when it pays out at the husband’s retirement, is paid to the wife.  Beware: the order dies with the husband so the income is lost to the wife. Ditto if she remarries.  This is only used by lawyers in pension planning on divorce in very specific circumstances.

I still come across cases where lawyers have neglected to pay enough attention to pension planning.  By way of example, they have neglected to obtain a value for the Additional State Pension for their client or the spouse on the other side.  You only need the modest little BR20 form to get this value.   Or they accept a pension scheme fund valuation for a final salary scheme instead of importing expert assistance to test the assumptions used in the valuation given.  The difference can run into tens of thousand of pounds.

But it is not just being savvy enough as a family lawyer to realise the valuation issues arising in pension planning on divorce.  The benefit, it seems to me, of making sure financial planning advice is obtained for a client is that they are guided on two key areas:

  • The need to continue to contribute to a pension fund after divorce – this is crucial.
  • The need for cash flow modelling from a financial planner during the divorce negotiations so that a specific income need allowing for pension payments after divorce is secured in a maintenance order before the divorce is finalised.

I brushed the dust off this post on pension planning (I have at least 10 draft posts lurking in the wings) when I read about recent research by the Phoenix Group on pension provision for women after divorce.  Some of the conclusions are worrying:

 

    • One in three divorced women don’t save any money at all
    • A staggering two in five (38%) have no idea what settlement they received after their divorce
    • Only 6% received pensions sharing order or a pension earmarking order 

All in all, this just reinforces the need for family lawyers to insist upon seeking pension planning advice on divorce for their clients.  Leaving it until after the divorce is simply too late.

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Financial planning in family law cases

April 15, 2013 in child maintenance, cohabitation, Financial planning, Pensions, spousal maintenance by Alan Larkin | No comments

 

Family lawyers should import financial planning

Family lawyers should import financial planning advice

I still surprise some of my clients, sitting in front of me with a pressing need for legal advice on a family law matter, when I take an avid interest in the identity of their other professional advisers and enquire about the financial planning that I expect to see in place.  I suppose they expect me to launch into questions about unreasonable behaviour or compromising comments on their spouse’s Facebook timeline.

I’m always surprised that they are surprised.  I wouldn’t dream of dealing with, say, a client who is facing divorce proceedings who owns a business, without talking to his or her accountant or financial planner.  I will want to understand how the business, and the family unit, ticks and how both may be affected by the advice I will be offering.

As a family lawyer dealing with divorce, civil partnership or separation issues I always have one eye on the financial planning issues that will arise in a case.  When I refer to financial planning, I do not mean sitting down with a divorce client and simply subtracting the outstanding mortgage from the value of the matrimonial home to work out the net equity.  No, I mean something much more sophisticated and, in general terms, beyond the skill set (and regulatory authority) of lawyers.

I will set out just a few examples.

Financial planning in divorce and civil partnership dissolution

With the exception of the most straightforward of divorce cases, perhaps one where there are no children or little or no assets, I would look to import financial planning advice for my clients.  The following scenarios are familiar ones:

  • The family home may need to be sold but this will involve exploring realistically the mortgage capacity of each spouse.  How much can be borrowed and what would be taken into account by a mortgage lender as income?  Will bonuses count?  If a wife is to receive maintenance payments from her husband after divorce, will this count as income in her name and improve her ability to obtain a mortgage advance?  
  • How much money will there be to live on: now, in five years’ time, or at retirement?  When family lawyers sit down with their clients to complete financial disclosure they need to detail all the outgoings their client will face.  Speaking frankly, for most lawyers, this has always been a bit of a chore.  There’s nothing exciting about working out utility costs or the public transport costs for your client to get to her new job.  Where’s the law in that?  So it tended to be done in a pretty slapdash way.  But this exercise is crucial.  The outcome impacts directly upon your client’s quality of life after divorce. It deserves some time and attention.  Financial planners use fairly sophisticated cash flow software that models the fluctuations in income and outgoings for clients over a long period of time.  In other words, they properly plan for the future.  This data is invaluable for the family lawyer who wants to negotiate the best outcome for their client in any divorce settlement.
  • Never mind the family home, what about the pensions?  How many times have I had a client say to me: “My husband says it’s not worth bringing pensions into it. We should ignore them”.  It is surprising how often pensions appear to be ignored.  I don’t ignore them.  I have them valued and then I decide whether they can be ‘ignored’.  Pension valuation can be difficult.  And let me make one thing clear.  £100 of pension funds for a female client is not the same as £100 for a male client.  You see, women live longer (just have a look at the figures kept by the Office for National Statistics).  So that £100 for a woman has to stretch further.  In simple terms, it will not yield as much income in retirement.  And here is another common refrain: “My husband says we should split the pensions in half.  That’s fair”.  Well it’s sounds fair, but it probably won’t be in the long run.  Any family lawyer who fails to obtain advice from an appropriate expert, such as a financial planner, with the relevant pension expertise, is selling their client short.
  • Maintenance payments for a spouse or children may have been agreed.  But what happens if the payer of maintenance dies?  I don’t understand why more lawyers don’t obtain advice for their clients on cost-effective insurance policies to pay out in the event of death.  This solves any cash flow problems for the ex-partner who would otherwise struggle with the financial burden of any children of the marriage.  And it also helps to prevent claims against the estate of the deceased under the Inheritance (Provision for Family and Dependants) Act 1975.

Financial planning for cohabitants

  •  The law in England and Wales does not provide adequate protection for couples who have cohabited, in some cases, for many years, and even had children.  Living Together Agreements can provide a sensible financial planning exercise for the relationship ahead.  It is particularly important where property may only be owned by one party or there is a common purchase but with unequal monetary contributions.  It is crucial for Wills to be put in place if proper provision is to be made for the other partner.  It is also possible to put in place nominations for death benefits under certain pension entitlements.  Life insurance, again, can become a sensible step to take to ensure that untimely death does not leave partners or children in the lurch.

I am fortunate in my day job as I can call upon my colleague, Sam Jermy, a financial planner, to help my clients.  The need to import financial planning advice is so integral to the family legal work that my firm undertakes that we formed a joint venture with a firm of chartered financial planners.  A free initial consultation is perfect to identify the issues that I need to concentrate on in obtaining the best outcome for my clients.  I appreciate that not everyone has access to a chartered financial planner.  But, if you find yourself encountering some of the issues raised in this blog post, ask your lawyer if financial planning advice is needed.  Don’t leave it until the doorstep of the court or the drawing up of the negotiated settlement – an opportunity for prudent and informed financial planning will have been missed.

STOP PRESS: I’m pleased to announce that Sam Jermy, a financial planner with Family Law Financial Planning, has offered some guest blog posts on the financial planning  work he conducts with family law clients.  In keeping with the vast Divorce Finance Toolkit budget at my disposal I have agreed a package of chocolate digestives and tea for Sam’s blogging contribution.  If I judge his blog posts to be particularly helpful for my readers I will even let him dunk the biscuits.  Watch this space.

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