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Bankruptcy – are pensions protected?

Joshua Croft, technical consultant at AJ Bell examines the rules

Bankruptcy is a form of debt relief available for anyone who is unable to pay their debts where they apply to the Insolvency Service to become bankrupt. From this point, the Official Receiver takes ownership of most of the bankrupt’s property with a view to distributing their assets to creditors. An individual’s pension though, in most cases, will be outside of the scope of the bankruptcy process. 

The Official Receiver is a civil servant who works for the Insolvency Service, they are the default Trustee in Bankruptcy (TIB). Where there are assets of value or a detailed investigation is required the Official Receiver will normally appoint an independent TIB at a private firm of insolvency practitioners or solicitors. 

A key piece of legislation on pensions and bankruptcy is the Welfare Reform and Pensions Act 1999 (WRPA), which came into effect on 29 May 2000. If a pension scheme is registered with HMRC it is an ‘approved pension arrangement’ under section 11 of WRPA. Approved pension arrangements are outside the reach of a TIB, which means they cannot simply demand funds from the scheme. 

However, under another key piece of legislation the Insolvency Act 1986 a TIB might be able to obtain a court order to recover any ‘excessive’ contributions. 

To claim excessive contributions, the TIB must present a case to the court that the contributions were paid with a view to putting them beyond the reach of creditors, and also that the contributions were excessive in view of the debtor’s personal and financial circumstances at the time.

Another option for the TIB is an Income payment order, again it can only be granted by a court, and it is a way of potentially claiming any kind of income the individual has. It doesn’t specifically relate to pensions, but it can be used to claim pensions income. 

For an income payment order the TIB must persuade a court that the debtor is receiving income from a pension that is beyond their ‘reasonable domestic needs’

Where the pension income is from a defined benefit scheme pension or annuity there is source of regular guaranteed income that the TIB can point towards. Where funds are held in a SIPP that is in drawdown but the member is not taking regular income, there is some doubt from a legal perspective as to whether the TIB can force the customer to start taking income.

If a debtor is over age 55 and has a SIPP that is not in drawdown they cannot be forced to crystallise benefits. This has been tested in the courts previously with a TIB arguing a debtor ‘became entitled’ to the pension income on their 55th birthday but this was dismissed by a judge confirming that at age 55, the debtor only becomes entitled to a ‘right to elect’ not a ‘right to payment’. This created a precedent that an uncrystallised pension fund is beyond the reach of an income payments order.

It’s worth noting also that the official guidelines from the Insolvency Service say that if an individual is 55 or over and has funds in a pension, they might not be able to apply for bankruptcy in the first place. This is because they could access those funds and use them to pay their creditors.

When an individual in financial difficulty is considering whether bankruptcy would be the best option for them they can be reassured that, broadly speaking, their pension will be protected. But because of the nuances of the legislation even at this difficult time they may benefit from taking advice to get to a situation which is both fair to their creditors and gives them some financial security in their post-bankruptcy retirement.  

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