New Insolvency Service guidelines on pensions

On 26 March 2015, the Insolvency Service published Undrawn pension entitlements: Summary of guidance for insolvency practitioners and debt advisors. With “pensions freedom” coming into force on 6th April 2015, the Insolvency Service’s aim was to clarify the murky situation around bankruptcy and pensions. Further clarification then came with the Guidance Issued to Receivers and Guidance Issued to Approved Intermediaries (my thanks to AJ Bell for sending these to me).

This article mainly looks at at the public policy implications of the Insolvency Service’s announcement. If you are already bankrupt/in a DRO or are considering one of them, it may be interesting background but for practical advice on the implications for your pension read:

 Why was the situation so murky?

Briefly the story to March 2015 was as follows:

• in 1999 the Welfare Reform and Pensions Act brought in protection for a bankrupt’s pension rights, so an undrawn pension could not be taken by the Official Receiver in bankruptcy;
• in 2012, the High Court judgment in Raithatha v Williamson was that someone who was bankrupt could be compelled to draw a pension and take the 25% lump sum and that the lump sum was “income” which could then be taken by the Official Receiver in an Income Payments Agreement;
• the pensions freedoms coming in in April mean that anyone over 55 may be able to access 100% of their pension. This gives a new option for paying off debts, which I have explored here;
• in December 2014, another High Court case, Horton v Henry, reached the opposite conclusion: that a bankrupt cannot be compelled to take an undrawn pension.

Update: This area was clarified in October 2016 when the Horton appeal upheld the judgment, see Pensions now safe in bankruptcy for more details.

The Insolvency Service’s announcement

Quotes in italics are from the “Summary of Guidance” document linked to above, followed by my comments:

“The following is a summary of the guidance issued to official receivers and Debt Relief Order (DRO) intermediaries on how to deal with undrawn pension entitlements in the light of the decision in Horton v Henry [2014] EWHC 4209 (Ch), pending the consideration of that decision by the Court of Appeal.”

I assume that as the rest of the announcement broadly follows the Horton v Henry decision, if the appeal is rejected then there won’t need to be any further changes. If the appeal is allowed, then … well it will depend on the details of the decision and the Insolvency Service will presumably have the option of seeking new legislation if it is uncomfortable with the result.

“1. Official receivers must not include an undrawn pension fund in any calculation for an Income Payments Order/Income Payments Agreement (IPO/IPA). Only pensions which are in payment at the date of the bankruptcy order may be considered in this calculation. Where an election is made to draw a pension before discharge then the income, including any lump sum, may be included in any calculation or revision of the IPO/IPA. The official receiver may not influence the bankrupt individual in making the election.”

“2. Similarly, intermediaries in DRO proceedings should not consider an undrawn pension fund, which might be drawn as the debtor is 55 or over, in the calculation of income. Only funds which are in payment as income should be included when considering surplus income.”

Follows the line of the Horton v Henry decision: undrawn pensions are protected in bankruptcy with a simple read across to Debt Relief Orders.

“3. Where the debtor is over 55 and has access to an undrawn personal pension fund both the official receivers and intermediaries are asked to consider whether the insolvency test has been met and, at the date of the application or petition the debtor is unable to meet their debts.

4. In bankruptcy the official receiver will consider whether it would be appropriate to seek an annulment of the order. In a DRO, an intermediary who is concerned that the available fund is considerably higher than the outstanding debt is asked to contact the DRO Team to establish whether the official receiver will in the circumstances grant the application.“

This wasn’t very explicit. I now understand that:
– tax and charges that would be paid if money is withdrawn from a pension will be taken into account who considering approving a DRO or whether to seek annulment of a bankruptcy
–  a defined benefit pension which is not in payment can be ignored for the purpose of assessing bankruptcy and DROs, only defined contribution pensions are relevant
– creditor petitions for bankruptcy will not be affected.

“6. Where a bankruptcy order was made on a petition presented before 29 May 2000, pension arrangements continue to vest in the trustee of the bankruptcy estate. All such cases where the official receiver is trustee are dealt with by the Insolvency Service’s Long Term Asset and Distribution Team pensions unit. Steps will be taken to realise the maximum amounts available for creditors in these cases, applying the changes in pension rules which will come into effect on 1 April 2015.”

Does this mean the pensions unit will be trying to take the whole pension? Why should the Official Receiver be allowed to “influence the election” in this situation if they don’t seek to do it in others?

Public policy implications

This appears to have many undesirable public policy implications:

• someone aged 54 will have their entire pension protected and can opt for bankruptcy or a DRO with no problem. But an older person could be forced to take money out of their pension to pay their debts rather than go bankrupt / have a DRO. This appears to be highly undesirable as good public policy as an older person has fewer years in which to try to rebuild their pension.
• it might also lead to people being more inclined to go bankrupt / apply for a DRO in their early 50s rather than try to work through their debts.
• someone over 55 with an undrawn pension that is insufficient to clear their debts (or below the “considerably higher” point?) would have it protected and be able to go bankrupt / have a DRO. Someone with a few thousand more would have to lose much or all of it to pay off their debts as the insolvency options will not be available to them. It seems really hard to justify this.
• bizarrely it may be in a debtors interest to increase the size of his debts prior to bankruptcy or a DRO or decrease the size of his pension pot if this would mean that his pension pot is then inadequate as it would then be protected.
• because creditor petitions are not affected (see above) in some situations a debtor could be considerably better off if a creditor petitions for bankruptcy.

The guidelines also appear to be contrary to the spirit of the 1999 parliamentary decision to protect pensions in bankruptcy. Whilst technically pensions are still protected in insolvency under the guidelines, not allowing people to opt for bankruptcy has much the same detrimental impact as raiding their pensions in bankruptcy would.

It is worth being clear about the trade-offs involved here. If pensions are used to repay debts then this will benefit creditors but at a longer term detriment to public finances as there will be a greater need for welfare benefits and for the government to pay care home fees.

Finally, the proposal to extend pension freedom to people who already have annuities in April 2016 [update – this has now been put back to April 2017] will make any Insolvency Service’s decisions in this area affect larger numbers of people.

Giving debt advice to someone aged 55 with an undrawn pension

The guidance is clear that undrawn pensions will not be taken into account when calculating income, for IPAs or for DRO eligibility. That is welcome. Also welcome is the fact that it appears to be the decision at the point of the bankruptcy petition that is important for the annulment issue, so the nightmare prospect of people who have gone bankrupt before April 2015 being affected is avoided.

But the references to the potential annulment of bankruptcy or rejection of DROs where people could have drawn money from a pension instead to pay off debts have added a considerable layer of complication. Case history will no doubt help debt advisors feel more confident about when a DRO is not likely to be approved (what is meant by “considerably higher”?) or when bankruptcy could be annulled, but at the moment advisers are not in a very comfortable position.  For DROs this is less serious as the DRO Unit will be able to advise Authorised Intermediaries – it would be good if a similar facility existed prior to bankruptcy.

The DWP’s deprivation of capital rules remain a potential problem. Although Universal Credit rules explicitly say that repaying debt will not be treated as deprivation of capital, the situation for other means-tested benefits is less clear.  Again case history will clarify this in time but it is not a comfortable position for debt advisors.