Is your pension safe in a DRO?

In April 2015, pension changes mean that many people over 55 can now withdraw some or all of their pension. You may be worried about whether your pension will be safe if you are already in, or have finished, a Debt Relief order (DRO), or if you are thinking about applying for a DRO.

The Insolvency Service has published a summary of its guidance on how Debt Relief Orders will be affected by the pensions changes.

I have tried to keep this article simple, but some people will need to take further advice from the debt advisor that is setting up their DRO. At the bottom of the article there are some links if you want to know more.

If your DRO has completed

If your Debt Relief Order has already finished, then your pension is completely safe. You can withdraw money from it or start taking an income from it whenever you want. This may not be such a good idea as it sounds – you may have to pay a lot of tax when you withdraw the money, there may be a lot of additional charges and it could badly affect any benefits that you receive – but these problems are not related to your DRO.

If your DRO has been approved but not yet completed

If your DRO has already been approved by the Official Receiver but you are still in the one year period before it ends, you MUST NOT withdraw any money from your pension or start taking an income from it until the DRO has ended.

By leaving your pension untouched, it will be safe and your DRO will continue however large your pension. You can take money out after your DRO completes (see above).

But if you did take some money out or started taking an income from your pension, you would have to inform the Official Receiver and your DRO could be cancelled, so your debts would remain – not a good idea!

If you are considering applying for a DRO

If you will be under 55 when your DRO is approved, it doesn’t matter how large your pension pot is, it will be ignored as you will be too young to access it at that point.

If you will be 55 or over when your DRO is approved, the Insolvency Service’s guidelines say:

“Where the debtor is over 55 and has access to an undrawn personal pension fund intermediaries are asked to consider whether the insolvency test has been met and at the date of the [DRO] application .. the debtor is unable to meet their debts … 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 is saying if you could have taken money out of your pension and that would have been enough to repay all the debts that would be included in your DRO, then you are not really “insolvent” and your DRO application will not be approved.

The guidelines say “personal pension”. I understand this refers to a defined contribution pension, where you have a “pot of money” that you could access. It doesn’t refer to a defined benefit scheme, where your pension will be linked to your final salary. If you have a defined benefit pension that isn’t yet being paid to you, this can be ignored (unless it will start to be paid to you within the one year DRO period.)

If your pension is smaller than your debts, then you don’t have a problem. Your DRO will be approved (assuming you meet the other criteria) and your pension will be safe.

The Insolvency Service hasn’t spelled out exactly what the “insolvent” calculation will be. It will take into account any tax that will be paid and the charges that would have to be paid to withdraw the money. The tax plus charges could come to a lot more than you might expect – see the links at the bottom of this page. There are also two grey areas:

• means-tested benefits could sometimes be affected if a pension is used to pay off debts. This would be unusual but if your advisor thinks it might apply to you, they can discuss your situation with the DRO team; and
• it’s not clear yet what “considerably higher” means.

“Help – this sounds complicated”

In practice it won’t be for most people and you don’t have to sort it out.

To set up a DRO you must go to an Authorised Intermediary, for example at your local Citizens Advice or National Debtline. They will work out if you meet all the DRO criteria  – total debts, surplus income etc. If you are over 55 with an undrawn pension, this will be another thing the Authorised Intermediary sorts out. If it is complicated, they will talk to the DRO team at the Insolvency Service, who will say if your DRO will be accepted.

Don’t assume that if your pension is larger than your debts that a DRO isn’t be possible. Because of taxes, charges and the grey areas above, your DRO may be accepted.

What are your options if a DRO won’t be approved?

If you are told a DRO will be rejected because your undrawn pension is too large, then it would probably be sensible for you to look at using some of your pension to clear your debts. This could include making full and final settlement offers to some of your debts. If taking your pension early would involve a lot of extra tax and charges, it may be better to postpone this for a while, possibly having a token payment debt management plan in the interim.

(The other insolvency options aren’t likely to be possible alternatives. If you qualify for a DRO because of your low spare income, an IVA is very unlikely to be affordable. There will also be an “insolvency” test in bankruptcy, so too large a pension will rule that out. )

Useful links

•  Get a Pension Wise appointment. This will make sure you are aware of all the different options for using your pension – there are a lot of them! The appointments are free and can be over the phone or face-to-face.
• Pension Wise won’t provide debt advice, but when you set up a Pension Wise appointment, you can also ask for an appointment at your local Citizens Advice to look at your debt situation and any affect on your benefits.
• How much tax might you have to pay: see the table in this article.
• You may face two sets of charges: early encashment charges (these depend on who you pension is with at the moment) and withdrawal and other charges (these additional charges that will depend on where you pension is when you take the money out).

*** Updated 15/05/15 with additional clarification eg around defined benefit / defined contribution schemes