It is sometimes said that the best negotiations are the ones where both sides feel dissatisfied afterwards. If so, this is never truer than in divorce proceedings, where both sides are likely to feel emotionally – and financially – drained by the time the case is settled.
Reaching a financial settlement on divorce is often a complicated and drawn-out process, which requires the former couple to gather information about all of their assets and a judge to sign off an agreed split of the marital assets. Divorcing couples often instruct solicitors to negotiate a fair division of marital assets, so that neither feels that they have ‘lost out’ compared to the other.
At this stage, the standard approach is to divide assets based on an equal split of value, whether that value is present or future. This can require comparing, for example, the value of a final salary pension with the marital home - the former is a significant source of future value, which can be discounted back to a current value, while the latter can only be valued in current terms.
Although it may sound like a financial planning exercise, this is largely based on government actuarial tables and a general legal doctrine of fairness, and if you do not have a firm grasp of your financial requirements, you may find yourself unable to retire on time or afford the lifestyle you have become accustomed to if you agree to certain divisions of assets simply for expediency or fairness.
Financial advisers can assist one or both parties (depending on the level of contention in the divorce) to understand what your future plans might require in terms of funding, and therefore what structure any settlement requires.
You should treat this as an opportunity to identify what your financial assets actually are, where they are kept and whether they are still suitable. During your marriage, you are likely to have formed joint decisions on what your future, including retirement, would look like. After a divorce, you will probably no longer have the same attitude towards investment risk, the same capacity for loss - or you may not be able to maintain the same lifestyle. A good financial planner can help you discover your new future by using tools that will enable us to model your lifetime financial forecast.
A typical client journey
The diagram below demonstrates a typical client journey, which often results in a financial adviser being engaged once a settlement has been agreed. However, is this too late? Have you missed out on crucial planning that could have avoided you both paying unnecessary taxes or provided a longer-lasting maintenance order? What difference might a financial adviser bring to your circumstances when engaged earlier? And when is the right time?
We believe it is important to engage a financial adviser at the point when you start to list your assets, and certainly before the divorce is finalised, in order to help create evidence of what is possible and sustainable that will assist both parties in arriving at a financial settlement which is fair and practical.
Sometimes this will be entirely in agreement with the solicitors’ assessments, based on a fair and simple division of assets, but other times an adviser may suggest splitting a pension pot that might otherwise have been left intact or that one party would be better keeping the house and offsetting the balance using investments.
As part of your settlement and in order to achieve a clean financial break from each other, one party is often awarded a lump sum (such as a pension or disposal proceeds from a property) rather than maintenance payments for a specified term, though these are still fairly common where the total marital assets are insufficient to provide the clean break.
Each settlement award has its own limitation and a good financial adviser should be able to help you make the best of your situation. This will take account of tax, risks and opportunities for each of the settlements awarded.
A pension award can be tax efficient during your lifetime and when passed to heirs upon your eventual death. However, if you are under the age of 55, you may not be able to access the benefits of the pension fund, which could cause problems if you do not have an alternative income source. Similarly, whilst the main residence may be a valuable asset, it is illiquid if you intend to live in it, therefore it is unlikely to provide an income or a lump sum to support your outgoings without significant planning.
It is also important to consider the less obvious taxes that might come into play following separation of assets. Capital gains tax is not a common occurrence for most people, especially as couples can freely transfer assets between one another to use both sets of annual allowance, but after separating a portfolio and deciding on a new strategy, there may be a need to sell a number of assets without the benefit of timing for tax efficiency purposes.
Ahead of deciding the split, it is important to consider which assets carry significant gains to ensure that one party does not bear a disproportionate amount of capital gains tax on the eventual disposal of the marital investments.
You will need to ensure that any lump sum awards are managed properly and in a manner that is aligned to your objectives, your attitude towards investment risk and your ability to absorb any losses. Sometimes, cash savings are the right place until you have clarity and certainty after you have considered your options.
Why should you engage a financial adviser?
If you choose to engage a financial adviser, they will be able to help by:
- Providing expertise in the analysis of your assets - such as pensions, which can be very complex.
- Designing a tax efficient division of assets.
- Creating an accumulation strategy ahead of retirement and an income strategy in retirement.
- Analysing upcoming life events and associated costs using financial modelling software, including numerous ‘what if’ scenarios.
- Identifying your attitude to risk and advising on what this means for you in terms of investments and the achievability of your goals.
- Assessing other financial risks and offering advice on how to mitigate these (especially relevant if you are awarded maintenance payments that could cease on the death of your ex-spouse).
- Advising on equity release plans if you need to turn your home into a lump sum or income to support your retirement.
Ultimately, they can help you make important financial decisions and prioritise your financial tasks.
In summary
Many people get divorced and subsequently seek financial advice. This is a period where some of the most important financial decisions of your life are being made and it would make sense to engage a financial adviser early who has experience in this field. By engaging earlier in the process, critical information can be provided to help you achieve a fair financial settlement and a better financial future.
Understanding the legal principles, process and the common mistakes of designing and agreeing a financial settlement is essential.
7 Key Financial Planning Steps on Divorce
Dealing with the financial aspects of a divorce can be incredibly complicated, so working with a specialist before the divorce is final, to agree your financial settlement, is vital.
To help, our sister company The Private Office, has produced a short guide, designed to help you achieve peace of mind before, during and after divorce.
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