PensionsJan 30 2018

Pensions in bankruptcy: All you need to know

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Pensions in bankruptcy: All you need to know

On that date, however, a statutory protection was introduced by the Welfare Reform and Pensions Act 1999, which meant a trustee in bankruptcy could not access the funds while they remained in a registered pension scheme. 

But trustees in bankruptcy can apply to the court for an income payment order if the pension is in payment or comes into payment before the bankrupt is discharged, so pensions are not entirely safe. In addition to these income payment orders, it is also possible for a trustee in bankruptcy to apply for an excessive contribution order if it appears that contributions have been made to a registered pension scheme to take them out of the bankrupt’s estate. 

Income payment orders

Income payment orders allow income payments from a registered pension scheme to be paid directly to the trustee in bankruptcy instead of the member, although they can’t force the fund to be crystallised to make the payment. An income payment order will usually be for a specific period, not more than three years, and can continue beyond the discharge of the bankruptcy if the court directs it. 

Excessive contribution orders

Legislation was introduced on 6 April 2002 to allow the trustee in bankruptcy to apply for a court order to recover contributions paid to a pension scheme – if that scheme was inappropriate to the individual’s circumstances and “unfairly prejudiced” the individual’s creditors.

The order can cover contributions made to approved and unapproved schemes by the individual or employer. In particular it extends the recovery of excessive contributions to approved personal pension/stakeholder schemes and Section 226 arrangements. 

When deciding whether creditors have been unfairly prejudiced, the court will consider in particular whether contributions were made for the purpose of putting them beyond creditors’ reach, and if the total amount of any contribution or accrued pension benefit was excessive in view of the individual’s circumstances when those contributions were made.

The order can include the following provisions:

• Trustees/scheme authorities pay an amount (not exceeding the lesser of the amount of the excessive contributions and the value of the individual’s rights – or excluded rights if the arrangement is an unapproved scheme – under the scheme) to the trustee in bankruptcy;

• Adjusting the liabilities of the scheme in respect of the individual or in respect of any other person that derive, directly or indirectly, from the rights of the individual (ie, typically reducing the amount of benefit or future benefit payable); and

• Recovery of trustees’/scheme authorities’ costs in giving effect to the order or providing information to the trustee in bankruptcy.

Where the order requires a payment to be made to the trustee in bankruptcy it must also require the liabilities of the arrangement to be correspondingly reduced.

Where excessive contributions have been recovered, the member’s benefits should be recalculated.  The legislation sets out that regulations may be made to provide for the recalculation of liabilities. However, no such regulations have yet been made, as the Department for Work and Pensions feels that at outset it is better to allow schemes the flexibility to choose the most suitable method of adjusting liabilities in each individual case rather than to prescribe a basis in regulations.

Court cases

In recent years there have been a number of court cases that have had an impact on pensions in bankruptcy, or may do so in future. The two main cases of interest were Raithatha v Williamson and Horton v Henry. The outcome of the latter case was in complete opposition to that in the former, but as we can only rely on the most recent case law it is where we are. What is more, another case, Hinton v Wotherspoon, agreed with the Horton v Henry outcome in principle. 

In the 2012 Raithatha v Williamson case the funds in question were not crystallised and the deputy High Court judge concluded that there was no logical reason why parliament would have intended there to be a distinction between a bankrupt who had drawn down their pension and was caught under the income payments legislation, and one who could draw but had not done so. This meant the trustee in bankruptcy could now make an appropriate order against Mr Williamson’s pension scheme in respect of both the available pension commencement lump sum and the annuity income. The case was appealed but was eventually settled out of court, which meant the matter wasn’t really resolved. It did however, cause concern within the pensions industry, because if the ruling were to have stood it would go against the general understanding that undrawn funds were protected in the case of bankruptcy. 

The subsequent 2016 Horton v Henry case has allayed fears about the effect of this ruling, and since it was taken to the Court of Appeal it holds greater authority as a precedent. In this case, the judge considered whether the bankrupt was entitled to the payment just by having the option to request a pension payment made. The judge decided this was not the case and said: “I have most anxiously considered the decision in Raithatha but I have, albeit with considerable reluctance, come to a different conclusion. Mr Henry is not entitled to payment under his pensions “merely by asking for payment”. There is a considerable variety of options open to him. It would only be after he had made elections that any payment would be due to him. Only then would he become entitled to any payment. I do not consider that there is any power in the court... or in the trustee to require Mr Henry to elect in any particular way.”

The case was appealed but it was turned down by the Court of Appeal. 

While every case should be judged on its own circumstance and particular details, it appears that Horton effectively reverses the apparent precedent set by Raithatha v Williamson for future bankruptcy cases. It is also the only case so far to have gone before the Court of Appeal, giving it extra authority. This should give some comfort that those with uncrystallised pension funds will not be forced to access them just to give rise to an income payment order. 

Death benefits and pension sharing on divorce

It is always essential that death benefit nominations are kept up to date, but even more so where an individual is bankrupt. This is because the trustee in bankruptcy can claim the death benefits if there is no valid nomination made and the bankrupt dies between the date of the bankruptcy order and the date of discharge. 

Should bankruptcy occur after a pension sharing order has been put in place but before it is implemented, the ex-spouse is treated as having rights under the scheme. So the pension will be protected from the trustee in bankruptcy in just the same way as if the pension sharing order has been implemented.

State pensions

Thankfully, state pensions do not form part of the bankrupt’s estate and are unlikely to be included in an income payment order, because income payment orders should not reduce the bankrupt’s remaining income below that which is necessary for meeting the reasonable domestic needs.  

Unapproved pension schemes

In the majority of this article I have talked about registered pension schemes. It may be the case that some unapproved pension schemes will also be exempted from the bankrupt’s estate. Additional regulations came into force in 2002 that set out which unapproved benefits will be excluded from the estate. 

Consequences

The pensions in bankruptcy puzzle is significantly simpler since the changes in May 2000, but consideration will need to be given to those on the brink of bankruptcy should they decide to access their pension funds to try to help. The impact of crystallising funds is such that making this kind of decision could completely change the financial future for the bankrupt, should the worst happen. 

In addition, the introduction of the pension freedoms means there isn’t a maximum income that someone can take, so income payment orders on flexi-access drawdown could in theory wipe out a pension fund in a single payment if the fund is already fully crystallised. This has yet to be tested in court, and should an income payment order be written in such a way to allow access to the whole fund it would entirely change the way pensions and bankruptcy is viewed.

Claire Trott is head of pensions strategy at Technical Connection