Maximising Tax Efficiency in Divorce Settlements
Put simply, managing tax effectively during a divorce can be the difference between achieving future financial freedom or not.
Understanding key tax considerations when splitting assets, handling maintenance payments, or managing investments ensures you optimise your financial position and avoid unexpected tax bills later on.
1. Splitting a Family Business
Key considerations
- If you continue receiving salary or dividends from a family business, you must pay tax on this income.
- If you give up your shareholding for a lump sum, avoid a share buy-back to prevent triggering Capital Gains Tax (CGT).
- Transferring shares to your spouse within three tax years of separation avoids CGT.
Action steps
Transfer or restructure your shareholding promptly to minimise Capital Gains Tax liabilities.
2. Spousal Maintenance
Key considerations
- Spousal and child maintenance are treated separately under UK law. Spousal maintenance applies when one partner cannot support themselves financially post-divorce.
- Payments are fixed in amount and duration, often with conditions such as ending payments upon remarriage or cohabitation.
- If you receive spousal maintenance from your ex-spouse’s taxed income, you do not need to pay additional tax.
- Lump sum (capitalised) maintenance payments are tax-free when received, but any returns generated from investing the funds will be taxable.
- Child maintenance payments are always tax-free. Use the gov.uk child maintenance calculator to estimate your entitlement.
Action steps
Secure your maintenance payments by taking out life insurance on your ex-spouse. The cost can be factored into your maintenance agreement.
3. Capitalised Spousal Maintenance
Key considerations
- A lump sum settlement provides a clean financial break and removes ongoing dependency.
- If your ex-spouse has high income but little capital, a lump sum may not be feasible.
- The lump sum itself is tax-free, but any income or capital gains from investing it will be taxable unless protected within an ISA or pension.
Action steps
Invest lump sum payments wisely to maintain long-term financial security and counteract inflation.
4. Property Transfers & Tax Implications
Key considerations
- Private Principal Residence (PPR) Exemption: If you sell your primary home due to divorce, PPR can exempt you from CGT, provided it was your main residence throughout ownership.
- The final nine months of ownership remain CGT-exempt, even if you moved out.
- CGT applies when selling or transferring any additional properties. Using both spouses’ annual CGT exemptions can minimise tax.
- Property transfers between spouses within three years of separation qualify for CGT exemption.
- Court-ordered property transfers are exempt from Stamp Duty Land Tax (SDLT).
- Buying a new property incurs SDLT. If you already own a home, you may need to pay the second home surcharge.
Action steps
Consult a financial planner or tax adviser before making property decisions to minimise unexpected tax liabilities.
5. Pensions & Investments
Key considerations
- Pension credits from pension sharing orders do not count towards annual pension contributions and won’t trigger an annual allowance tax charge.
- The abolition of the Lifetime Allowance means new tax rules limit how much tax-free lump sum can be withdrawn from a pension.
- Pension withdrawals are taxable in the recipient’s hands.
- Investments generate taxable income unless held in a tax-efficient wrapper such as an ISA or pension.
- Capital gains tax applies to selling non-wrapped investments such as shares or long-term incentive plans.
Action steps
Assess your tax position before dividing assets to maximise the tax efficiency of your financial settlement.
