In March the Government announced new pension reforms. From April 2015 pensioners reaching 55 years will be entitled to draw down their entire pension pot, to do with as they wish. Pensions minister Steve Webb was famously quoted as saying that pensioners should be able to “buy a Lamborghini” with their pension pot if they so wish. And if pensioners subsequently ran out of money, well, they would have the state pension to fall back on, after all.
This approach by the Government places an enviable amount of choice in the hands of the solvent pensioner. With the right tax and investment advice they can draw down a tax free lump sum equivalent to 25 per cent of their pension pot each year, and the entire balance could be drawn down, subject to the individual’s marginal rate of tax. Or they could invest in an annuity to ensure an income for their retirement and for their family. Or they could blow it all and buy a round the world trip or a sports car. The choices are endless. But what is clear is that the pensioner has a choice about how best to provide for their retirement.
All well and good, whatever you might consider about the possible impact on the public purse in years to come. But the reforms have had an unforeseen consequence in the world of personal insolvency. What about the insolvent pensioner, and their dependants?
Back in 1999 the Welfare Reform and Pensions Act made changes to the way in which pensions are treated in bankruptcy. The public policy driver for change was that debtors should have proper provision for their retirement. Pensions were effectively “excluded” from bankruptcy. Annuities that had fallen into payment were treated as part of income, and excessive contributions might be reclaimed, but the pension pot itself was out of bounds.
All that changed in 2012, following the decision in Raithatha v Williamson, where the High Court held that a bankrupt's right to receive income or draw down on his personal pension could be the subject of an income payments order (IPO). The bankrupt had a substantial pension pot (£1 million) but had chosen not to draw it. What the court effectively did was treat the "undrawn" pension as if it was income the debtor was entitled to under s.310(7) Insolvency Act 1986. The lump sum element of the pension pot was no longer out of bounds.
The case was appealed, but the appeal settled. However, we understand that a judgment in a new case will be handed down in the next few weeks in which it was argued that the decision in Raithatha should not be followed. Watch this space for an updated briefing but as we write Raithatha is still good law.
The decision in Raithatha opened the door to trustees in bankruptcy seeking income payments agreements and IPOs from bankrupts of pensionable age seeking their 25 per cent lump sum as income.
Of course from April 2015, the whole pot, not just 25 per cent, will be available for draw down, so what will happen to a debtor who will reach 55 on or before that date? What of bankrupt pensioners? Can a trustee in bankruptcy, applying the logic of Raithatha, require a bankrupt pensioner to draw down his entire pot, leaving nothing to provide for his retirement? Could the pensioner be required to draw down all of the pot in one year taking an immediate tax hit, rather than in a tax efficient manner?
On the face of it, it would appear that a trustee could do just that. If the “pot” can be drawn down as income, then a trustee in bankruptcy could claim it, in full, in one hit.
There are arguments to the contrary: section 310(2) of the Insolvency Act 1986 provides an income payments order should not have the effect of reducing the bankrupt’s income below that which is necessary for meeting the reasonable domestic needs of the bankrupt and his family. Shrewd bankrupts with large pension pots will no doubt argue that this extends to providing for the needs of the bankrupt and his family for retirement, and that the state pension is not sufficient.
That argument is attractive, until you consider that a “normal” pensioner could blow his entire “pot” on that Lamborghini if he chose to, and fall back on the state pension as suggested by the pensions minister. Why shouldn’t an insolvent pensioner pay his creditors and fall back on the state pension like his (formerly) more prudent counterpart? But on the other hand, his sports-car driving counterpart has made a decision not to provide an income for the future, whereas the bankrupt has no choice.
How are you affected?
- No doubt trustees in bankruptcy are alive to these issues and will be reviewing the pension rights of bankrupts reaching 55 before their discharge (which is the cut off point for a trustee applying for an IPO).
- Nominees of voluntary arrangements will need to consider how a debtor’s proposals deal with pensions. If a debtor reaches pensionable age during the period of the IVA, creditors may be looking for a greater contribution to compensate the creditors if they think they would get their hands on the pension pot in bankruptcy.
- And what about a debtor? A debtor, with a pension, approaching 55 in the next one or two years should take advice immediately about the options available to him in view of the uncertainties surrounding what will happen to his pension in bankruptcy after April next year. Bankruptcy should certainly never be entered into lightly, but where a pension pot is likely to be affected a debtor must take advice.
- And if a debtor decides to cash in his pension and buy that Lamborghini before he goes bankrupt? Well, the trustee will have that too…