EIM75050 - The taxation of pension income: pension paid to former spouse or civil partner

Overview
Pension sharing
Attachment orders

Overview

Pension savings are often considered as part of a financial settlement on divorce or dissolution of a civil partnership. The courts can make an attachment order or a pension sharing order in respect of the pension rights of either of the parties.

The statutory provisions that govern the financial settlement between former partners determine who is to be charged to tax on the pension income concerned. For example, unlike a pension sharing order, an attachment order does not transfer the ownership of the portion of pension to the ex-spouse or civil partner. Therefore, the pension income remains that of the pension scheme member and they remain chargeable to Income Tax on the whole amount.

Pension sharing

Pension sharing was introduced by the Welfare Reform and Pensions Act 1999 with effect from 1 December 2000, as an alternative to an attachment (earmarking) order. Pension sharing occurs when a couple divorce or dissolve a civil partnership.

As part of the financial settlement on a divorce or dissolution, it is possible for one party to acquire a share of the value of the other’s pension rights. To do this they will have to apply to the court to obtain a pension sharing order which will award the one party a percentage of the value of the other’s pension rights.

The process in Scotland is the same, although the pension sharing order might be achieved by a legally binding agreement rather than by a court order.

When the pension scheme administrator receives a pension sharing order, the scheme member’s benefit rights held within the scheme are valued to give them a cash equivalent. The cash equivalent is then reduced by the amount stated in the pension sharing order. This reduction in the member’s pension rights is known as a pension debit. The amount given to the ex-spouse or ex-partner is called a pension credit. This must be used to provide the recipient with their own pension benefits. This may be under the same pension scheme or the ex-spouse or ex-partner may choose to transfer it to another pension scheme.

Further information on pension sharing orders can be found at PTM029000.

Taxation of pension sharing arrangements

Under these provisions, the ex-spouse or ex-partner will be entitled to receive a pension in their own right which will be taxable in his or her hands. The exact tax treatment depends upon the type of scheme they receive the pension from and how the pension is taken. For example, if a pension credit is under a registered pension scheme the ex-spouse or ex-partner can choose to take part of it as a lump sum and the rest as ongoing pension payments.

Attachment orders

An attachment order effectively earmarks a portion of the income or the lump sum or death benefit of a pension (or a combination). These orders may also be referred to as earmarking orders.

A percentage of the pension, lump sum or death benefit is paid to the ex-spouse or ex-partner either immediately (if the pension is already being paid) or from a date in the future when the pension is drawn (for example at normal retirement age).

In England, Wales and Northern Ireland these payments can be made from pension income, lump sum or death benefit.

In Scotland they can only be made from a pension commencement lump sum.

‘Ownership’ of the pension rights is not transferred to the ex-spouse or ex-partner. As a result, the pension remains the income of the pension scheme member and they remain chargeable to Income Tax on the whole amount. There is no deduction available on the amount paid under the attachment order. The pension received under the order is tax-free in the hands of the ex-spouse or ex-partner.