Divorce to access DC pension tax efficiently.

[Rollercoaster1920]

This is purely theoretical, but I was wondering if it is a pension tax loop hole.

Situation where a married couple have one high earner with v.large DC pension and the other person has low/no DC pension.

Would it be advantageous to divorce, with pension split equally to both visa a pension transfer. Both would then be able to take 25% out tax free, so 2x £268k.
Yet if they stayed together with pension in one person's name then only half the amount could be withdrawn tax free.

They would lose inheritance transfer to spouse tax free though, but if inheritance went straight to children it could be irrelevant.

I also wonder about a similar scenario where an age gap couple with the older person having much lower pension pot. If they divorced and moved pension to older person they could get access to the tax free money earlier.

I suppose a third scenario would be divorce to equal pension pots which could lower tax losses when drawing down the pension due to making use of personal allowances and keeping in lower income tax bands.

In all scenarios above the divorce would be purely for the financial reasons. They could stay together as before!

Is this a 'thing' people do?

You havent done your maths properly here. 25% of £268 is 67k. 25% of 134 each is 33.5.

so it makes no difference.

No its a ridiculous idea, I work with older people and deal with thier finances when they need care I have never heard of anyone doing this for financial reasons.
They would lose the inheritance tax benefit if they divorce which could be really significant.

That’s not what she means. £268k is the max tax free cash for one person. What she is considering is splitting a very large DC pot so that they can both take the max tax free cash each. Her maths is correct and I have seen this suggested before but there was a good reason why not to do it but I can’t remember what it was. Will come back when I have found it but inability to inherit assets IHT free is one of them.

What about divorce - split the pension, take out the tax free sum each - and then get married again - benefit from inheritance tax allowance when the time comes.

This would be challenged by HMRC under general anti avoidance principles. A pension sharing order is a court supervised process and is not without a cost so you would need to convince a court that the divorce was genuine.
You would need to live separately and possibly sell other joint property to be able to also split that.
if you had wills leaving your estate to each other that would look suspicious and you would not qualify for IHT spousal relief.
Im sure there is more but it is not a loophole that HMRC are unaware of and is very unlikely to work but could land you with professional fees to implement it, more fees to defend yourself in an HMRC investigation and then penalties when you lost the case.

I think you’re right. Divorce - even if all out and then remarry as financial equals
it’s worth considering

I think may be easier if higher earner retired first and the lump sum goes into the lower earners pension provided you have enough roll over etc

But it’s no fault divorce now so you don’t have to prove anything, just put the paperwork in.

I hadn't considered that getting remarried would return the inheritance tax transfer.

So it is theoretically possible, and a bit of a loophole. It would be tax avoidance, and could be seen as tax fraud.

It would be a real pain to organise this, and seems yet another example where individual taxation penalises those that have a stay at home parent.

This would only work if done over a long period of time as you can’t pay in more than you earn in any financial year.

As far as I am aware (not a solicitor and no direct experience) a finance sharing agreement in a no fault divorce still needs to be approved by a court and a pension sharing order definitely needs to be court approved.

Agreed this a big disadvantage for families where one parent is a higher earner and the other either a low earner or SAHP. It’s not even as simple as planning in advance for the higher earner to pay into a spouses scheme instead of their own as the higher earner won’t get high rate tax relief for paying into someone else’s pension.

Ah yes, of course 😀

Very few people will have big enough dc pots for this idea to be relevant, the previous lifetime allowance would have caused most people who plan their investments to keep their pots below this amount. Irl surely the high earner would have given money to their spouse to put into their own pension.

Agreed this won’t apply to many. However not all higher earners plan effectively and the calculations are complex eg. a main earner with earnings in the 60% tax trap bracket can get effective tax relief at 60% on a significant contribution. If the spouse is a SAHP with no earnings the max you can pay into with tax relief is £2880 pa, even for a low earner the calculation is complex and the resulting benefit is borderline. Hence there is incentive for the higher earner to keep adding to their own scheme despite being above the amount which gives max tax free cash until the expected tax rate on withdrawal is as high as the tax relief on paying in.

I think HMRC are aware of the divorce, split pensions then remarry scheme, but the number of people for whom it would be beneficial is minimal and fewer would have contemplated it, as PP says the old rule about the lifetime limit would have reduced the number of people with excessive funds, likewise the new rules about nominated beneficiaries and tax free transfers, will affect people amassing large funds, not that they were particularly useful unless you died before you were 75.

General pension guidance is to have a £1m pension pot if you want £50k per year income. So not too far off 'normal' for middle class, non final-salary people.

This may become more relevant to more people if the thresholds don't move up with inflation.