If an individual cannot repay their debts and a bankruptcy order is made against them, the Official Receiver (OR), or a Trustee in Bankruptcy (TIB) (if an insolvency practitioner has become involved), would be appointed to:
a) take control of (most of) the bankrupt’s assets; and
b) sell those assets and use the proceeds (after its own charges) to repay at least part of the money owed to the creditor(s).
Usually, a co-operative individual would be discharged from their bankruptcy within one year. From that point, the OR/TIB would normally retain control of the individual’s former assets but the individual would be free to re-build their finances and acquire new assets which would not be subject to the original bankruptcy order.
Impact of bankruptcy on pension benefits
The following points relate to an approved pension scheme (before 6 April 2006) or a registered pension scheme (RPS) (from 6 April 2006).
The effect on pension benefits is different depending upon when the bankruptcy petition was made.
1. Bankruptcy petition made before 29 May 2000
Retirement annuity contract (RAC)
If an individual held benefits within a RAC and they were declared bankrupt, it would have been possible for the OR/TIB to assume control of the RAC and to have taken any action that the individual could have taken. This would have included:
- vesting (drawing) the RAC benefits; or
- transferring them into a personal pension (from which they could vest the benefits from the bankrupt’s 50th birthday rather than from the bankrupt’s 60th birthday under RAC rules)
(Some personal pension providers required both the OR/TIB and the bankrupt individual to sign a transfer application).
Therefore, the OR/TIB could use the tax-free cash (TFC) and/or income benefits to repay the bankrupt’s creditors.
Fully insured or self-invested personal pension
Originally, if an individual held retirement benefits within a personal pension and they were declared bankrupt, the benefits would have been treated in the same way as if they were held in a RAC.
Therefore, the OR/TIB would have taken control of the bankrupt individual’s pension benefits and could have vested the TFC and/or income benefits from the individual’s 50th birthday to repay the individual’s creditors.
However, the situation changed in the mid-1990s and some providers introduced a ‘forfeiture clause’ into the Rules of their insured and self-invested personal pension schemes. Although the validity of forfeiture clauses was questioned by the OR and TIBs, the existence of a forfeiture clause generally meant that the OR/TIB was unable to access a bankrupt individual’s pension benefits within the personal pension scheme concerned.
A forfeiture clause usually stated that if an individual member was declared bankrupt, they lost their entitlement to any lump sum and/or pension rights in the personal pension scheme immediately.
Instead, the administrator (for a contract-based scheme) or the trustee(s) (for a trust-based scheme) would be empowered to use its/their discretion to distribute the money to any other potential recipient(s) under the Rules of the scheme when the bankrupt individual reached their 50th birthday (or at any other time up to their 75th birthday). Typically, these recipients would have included any member of the bankrupt individual’s family.
Occupational pension scheme
If an individual held retirement benefits within an approved occupational pension scheme and they were declared bankrupt, it was not possible for an OR/TIB to take control of the bankrupt’s benefits, owing to the particular trust structure used to establish such a scheme.
Benefits emerging from any approved pension scheme
Even where the OR/TIB could not access a bankrupt individual’s benefits whilst they remained within an approved pension scheme, any TFC and/or income payments which were made from such a scheme to that individual could be accessed by the OR/TIB and used to repay the bankrupt’s creditors.
2. Bankruptcy petition made from 29 May 2000
Usually, if a bankruptcy petition was made from 29 May 2000 and an individual with benefits within any approved pension scheme or RPS was made bankrupt, the Welfare Reform and Pensions Act 1999 prevented (and continues to prevent) the OR/TIB from accessing those benefits whilst they remain in the scheme.
The one exception would be where any contribution(s) had been deliberately made into a pension scheme shortly prior to the bankruptcy to try to prevent the OR/TIB from accessing that money. In that situation, the OR/TIB could apply for a court order that would remove the relevant amount from the scheme, allowing the OR/TIB to use it to repay the bankrupt individual’s creditors.
However, any lump sum and/or income payment which was made from the pension scheme to the bankrupt individual could be accessed by the OR/TIB and used to repay the bankrupt individual’s creditors.
Income payments agreement (IPA) or income payments order (IPO)
If a bankrupt individual received income from a pension scheme, the OR/TIB could enter into a voluntary agreement with, or require, the bankrupt individual to make payments from that income which would be used to repay their creditors.
The OR/TIB would consider the bankrupt's regular expenditure (including expenditure in respect of their family household) when deciding whether the bankrupt could afford to make such payments from their disposable income.
If so, the OR/TIB could ask the bankrupt to enter into a voluntary binding IPA so that the bankrupt paid an agreed amount from their income to the OR/TIB. This would not require the involvement of a court.
Alternatively, the OR/TIB could ask a court to grant an IPO (with or without the bankrupt individual’s consent). An IPO could:
- suspend the individual’s discharge from bankruptcy; and/or
- take money directly from the bankrupt’s earnings, or pension, income.
The OR/TIB should not try to obtain either an IPA or an IPO if the bankrupt’s only source of income was from state benefits. This would include all forms of income supplement and support provided by central, or local, government, such as universal credit, income support, job seeker's allowance, disability living allowance, incapacity benefit, council tax benefit, state retirement benefit, child benefit and all forms of tax credit (child, working and pension).
Any IPA or IPO would normally apply for a maximum of three years from the date of the agreement/order.
Recent legal debate regarding pensions and IPOs
Prior to the Raithatha v Williamson High Court ruling on 4th April 2012, the general view was that only pension income that was actually in payment could be subject to an IPO.
However, the ruling in that case was that an IPO could be made in respect of income available under an ‘undrawn’ pension (any pension rights within an RPS in relation to which the bankrupt could determine the method and timing of the payment). Consequently, the ruling meant that a court could compel an individual (who was eligible to take their benefits but had not yet done so) to draw those benefits.
This judgement was contentious and an appeal was due to be heard by a higher court. However, the appeal was dropped following an out-of-court settlement between the parties concerned.
The legal debate continued following the High Court ruling in the Horton v Henry case on 17th December 2014. The court ruled that an undrawn pension could not be subject to an IPO. However, the judge recommended that the Court of Appeal should review this point. An appeal was subsequently raised against the High Court’s ruling.
Before the Horton v Henry appeal was heard:
- in the Hinton v Wotherspoon case on 19th May 2016, the High Court upheld the approach taken in the Horton v Henry case; and
- the Insolvency Service issued guidance to ORs on how to deal with undrawn pension entitlements pending the Court of Appeal’s review.
The guidance stated that an OR should not include an undrawn pension fund in any IPA or IPO calculation, i.e. only pensions which were in payment should be considered. Where an election was made to draw any pension benefits before the bankrupt was discharged from bankruptcy, the income (including any lump sum) could be included in any IPA or IPO calculation (or revision of such a calculation). However, the OR should not influence the bankrupt individual to make any such election.
On 7th October 2016, the Court of Appeal in the Horton v Henry case upheld the High Court’s original ruling that an undrawn pension could not be subject to an IPO.
Consequently, it is likely that the content of the Insolvency Service’s temporary guidance mentioned in 2) above will be formalised on a permanent basis.
Detailed information regarding bankruptcy and pensions can be found in the link to Chapter 61 of The Insolvency Service’s ‘Technical Manual’ below.
Further information regarding IPAs and IPOs is contained within the following link. 'The Insolvency Service'.
The Insolvency Service has also published the following ‘What will happen to my pension’ guide which explains how insolvency will impact a bankrupt’s pension benefits.
Created October 2016