Key Takeaways:
- Divorce can significantly impact your tax and estate planning position.
- Timing is vital (especially for Capital Gains Tax reliefs).
- Pensions are often undervalued but can be one of your largest assets.
- Failing to update your will and protection policies can lead to unwanted outcomes.
- Early financial advice and reduce tax and improve long-term security.
Why financial planning matters during divorce
Divorce isn’t just a legal process. It’s a major financial turning point that can shape your long-term future.
During divorce, many people focus on the short term, particularly in the immediate division of assets and childcare arrangements. In truth, however, the longer-term tax and estate planning implications are often equally important.
It’s easy to focus on immediate decisions during divorce, but overlooking the long-term impact can lead to unexpected tax bills and missed opportunities.
Divorces are often times of turmoil. Discussing the new normal with your financial adviser gives confidence that your financial plan reflects your new circumstances and goals.
Key tax and estate planning considerations
Every financial decision you make during divorce can have significant tax consequences, affect your long-term financial security and impact the legacy you leave behind for your family.
Some of the key considerations include:
- Will transferring assets trigger a tax liability?
- What happens to my pensions?
- Am I still on track to meet my financial goals?
- Do I need to update my will?
- Does my Inheritance Tax liability change?
- What happens to my life insurance policies?
If you’re concerned about the answer to these questions, we recommend reaching out to Cooper Associates Wealth Management for a zero-obligation consultation with our team of expert financial advisers.
How does divorce impact Capital Gains Tax (CGT)?
One of the most important tax considerations during divorce is Capital Gains Tax (CGT).
CGT is payable on the increase in value of certain assets on sale or transfer. These assets typically include:
- Personal possessions worth £6,000 or over.
- Property that isn’t your main home.
- Your main home if it has been used for business purposes or let out.
- Any shares not held in a protected wrapper such as an ISA.
Transfers of assets between spouses are free from CGT on a ‘no-gain no-loss’ basis. However, divorce changes these rules.
Transferring assets before the divorce is final
The timing of asset transfers can have a significant impact on taxation.
Current UK legislation allows for a three-year period from the point of formal separation during which assets can continue to be transferred between separated spouses without triggering CGT.
This provides more flexibility than previous legislation and allows more time to negotiate financial settlements.
However, timing remains crucial. Understanding the exact timeframes is essential, as missing the relief period may mean transfers trigger CGT, resulting in considerable tax liabilities and a worse net position than originally anticipated.
Transferring the family home
The family home typically benefits from Private Residence Relief, meaning that any gain is exempt from CGT.
However, this may not always be the case, and complications can arise when:
- The property is subsequently retained to rent out or has previously been rented out.
- The property is retained for children.
- One party keeps the property while the other receives other assets.
Understanding how reliefs apply to the family home is important, as it can prevent further unexpected tax liabilities and ensure a fair division of assets.
How does divorce impact Inheritance Tax (IHT) planning?
Married couples benefit from several valuable Inheritance Tax reliefs which may no longer apply following divorce.
Transferable nil-rate bands
Each person in the UK receives the £325,000 nil-rate band (NRB), and those leaving their primary residence to their direct descendants (children or grandchildren) benefit from an additional £175,000 residence nil-rate band (RNRB).
If leaving all assets to your spouse, there is no liability on the first death in a marriage. As well as the assets, these reliefs transfer to the surviving spouse, resulting in £1,000,000 of total relief for married couples.
Divorce removes the entitlement to this transfer, effectively halving the relief available.
Loss of spouse exemption
Assets transferred between two spouses are generally exempt from Inheritance Tax.
In instances where both spouses are UK domiciled, the amount that can be transferred is unlimited.
In instances where the transferor spouse is UK domiciled but the receiving spouse is domiciled outside the UK, the exemption is capped at £325,000.
Following a divorce, these exemptions no longer apply, and assets transferred will be treated as potentially exempt transfers (PETs) and will be subject to the seven-year rule.
Reviewing your estate planning after divorce
Reviewing your estate planning strategy early after divorce can help to ensure that your estate remains tax efficient and that you can make efficient use of reliefs while available.
If your estate planning is not reviewed to reflect your new marital status, the financial impact of divorce can have knock-on effects for future generations too.
How does divorce impact pensions?
Pensions are commonly one of the most valuable assets that we own, but are often overlooked during divorce proceedings as they aren’t immediately accessible.
Pensions represent future income rather than current wealth, and as a result valuing them is more complex than more immediately tangible assets like property or shares.
Pension Sharing Orders
A Pension Sharing Order allows pensions benefits to be divided between spouses as part of the divorce settlement.
This provides a clean financial break, with each person holding their own pensions separately going forwards.
Pension Attachment Orders
Less commonly, Pension Attachment Orders direct a proportion of pension income to a former spouse.
These arrangements are less common, as a financial link remains between former partners and typically provide less clarity and resolution.
Pension Offsetting
Pension offsetting allows one partner to retain a larger proportion of pension wealth while the other partner receives additional assets, such as a greater share of property or shares, to balance the equation.
This may simplify negotiations. However, comparing pension value with other asset values can be complex due to the difference in tax treatments, assumed value growth over time and access restrictions.
Reviewing your investments after divorce
Following a divorce, it is possible that you may need to reconsider your investment strategy.
Reviewing your attitude to risk, the ease with which you need to access your money and the amount that you contribute to your investments ensures that your wider financial strategy is completely aligned with your overall objectives.
Discussing these things with your financial adviser helps them to adjust your investment strategy to reflect a significant change in your life while maintaining tax efficiency.
How divorce impacts life insurance and protection policies
Protection policies are often overlooked during divorce, despite playing a critical role in solidifying your long-term security.
Many life policies remain payable to the original nominated beneficiary unless changes are actively made. If your former spouse remains named on the policy, the proceeds may not be distributed as you wished.
Likewise, a protection policy set up to cover a joint mortgage may no longer reflect your circumstances or wishes.
Reviewing protection policies after divorce ensures that cover remains aligned with your new circumstances and avoids unnecessary premiums for policies that no longer serve their original purpose.
Other important considerations
Updating your will
Divorce changes how certain provisions within your existing will are treated. Former spouses are no longer entitled to benefit (unless specific provisions are in place), and if they were appointed as an Executor of the will, their appointment is automatically revoked.
However, divorce does not automatically produce a new will which expresses your new wishes.
An outdated will may leave unintended beneficiaries inheriting part of your estate or appoint unsuitable executors.
Reviewing your will also provides an opportunity to consider whether additional wrappers, such as trusts, should be included to more effectively manage wealth across generations.
As your broader financial plan changes after divorce, your will should be updated to reflect these changes, ensuring that your assets are distributed in a way that supports both your family and your own legacy objectives.
Lasting Powers of Attorney
It’s common for people to grant their spouse control under a Lasting Power of Attorney.
Divorce may terminate some appointments automatically, but this depends on several factors including the circumstances and the type of appointment made.
Even when an appointment ends, it is important to review your position to ensure a suitable new Attorney is put in place should you lose capacity to deal with your own affairs.
Common mistakes to avoid in divorce
Typically, costly mistakes occur when financial planning is delayed until after the divorce has been finalized.
Some of the most common mistakes people make include:
- Missing the Capital Gains Tax deadline.
- Forgetting to update wills.
- Leaving your former spouse as a beneficiary.
- Ignoring or postponing Inheritance Tax planning.
- Undervaluing pensions.
- Assuming assets of equal value are equal in practice.
- Failing to review protection policies and forgetting to update them.
- Not seeking specialist financial advice during divorce proceedings.
Finances and Divorce: FAQs
Do you pay Capital Gains Tax when you divorce?
Not usually. Transfers between spouses are exempt if made within a certain timeframe.
What happens to pensions in divorce?
Pensions can be split, shared or offset, depending on the type of settlement and the goals of each party.
Does divorce impact Inheritance Tax?
Yes. Divorce may reduce the total value of allowances available and remove spousal exemptions.
How Cooper Associates Wealth Management can help
Once the legal divorce process is underway, attention should quickly turn to your long-term financial plan.
Divorce often presents an opportunity to reassess your financial priorities, establish new savings goals and create a plan that aligns with your new future goals.
Working with a financial adviser can help you to create a personalized, comprehensive plan based on your circumstances, covering:
- Retirement planning.
- Investment strategy.
- Budgeting.
- Debt reduction.
- Estate planning.
- Additional fund management (such as paying for education).
By your side for life’s big moments
At Cooper Associates Wealth Management, we believe that financial planning is about so much more than managing investments or reducing taxes.
It’s about helping people navigate life’s most defining moments with confidence and clarity.
Whether you’re separating finances, reviewing plans or are looking to protect wealth into the future, our advisers take the time to truly understand your circumstances and your aspirations for the life you want to lead.
We don’t believe in off-the-shelf. That’s why we provide holistic, bespoke financial planning from investment strategies and estate planning to protection and cashflow forecasting.
Whatever turns life takes, you shouldn’t have to navigate it alone.
If you’re going through a divorce or have recently separated, get in touch today and book a zero-obligation consultation to discover how we can help guide you through the journey.
*The value of investments and pensions can fall as well as rise, which means you may get back less than you originally invested.
