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Will moving goal posts create a bankruptcy bonanza?

We consider whether the new right of total commutation of pension creates a bonanza for the trustee in bankruptcy, where the bankrupt has pension savings.

When the Chancellor of the Exchequer announced moving away from the requirement to use a pension fund to purchase an annuity and to allow the fund to be totally commuted for a lump sum (taxed only at the individual’s marginal rate of income tax), some cited this as an example of the Government trusting people with their own money.  We explore below alternative reasons why this move may have been made.

Firstly, the state has given income tax relief in respect of deferred life annuity premiums for individuals since 1853.  In 1916 it was extended to those taken out by superannuation schemes. The familiar system of approval (where the rules of the scheme conform to certain criteria) was introduced in 1921. Acting out with those rules could incur serious tax consequences.

That system moved on in 2006 when the Finance Act 2004 simplified the rules into the present, more complicated system. The tenet there was that people did not have to stick to a set of rules, but if they did something which was ‘unauthorised’ then a tax charge would arise. That tax charge would be in the form of an unauthorised payment charge (at a rate much higher than the income tax rate), and in certain circumstances this could give rise to an even higher sanction charge.

Secondly, it is not surprising that tax relieved pension contributions should be expected to lead to a pension.

Thirdly, and what most overlooked at the time, was that this new initiative has been predicted to bring in as much as £2000m to the Treasury.

The Government having constructed the 2006 taxation regime for pension schemes were not long in setting about making it even more complicated. In addition, the Government and its agencies (principally the Pensions Regulator) became concerned about pensions liberation which its own system engendered.

It took a while for someone to notice that this new initiative is similar to an existing scheme in Australia, where many elderly have availed themselves of this opportunity to see out life in penury. A recent survey of Independent Financial Advisers showed 77% of them thought the greatest challenge would be of people spending their whole pension fund. 67% saw threat from clients not understanding the difference between advice and the form of guidance which need only be given.

But these are not the most striking of outcomes. Many might have thought that the Pensions Act 1995 afforded protection of pension savings, subject to the possibility of challenging excessive contributions. However, as early as 1997, a case (Shand’s Trustee, still unreported) in Hamilton Sheriff Court allowed the permanent trustee of a sequestrated estate to exercise the option to take a tax free cash sum. Similar decisions (Raithatha v Williamson and Blight v Brewster albeit under separate English legislation) were reached in the English High Court after the introduction of the 2006 tax regime. The English cases could be accused of lacking rigorous analysis of the legal concepts involved. One case (Raithatha) was appealed but settled before an appeal judgment was given. However, we did seem to have some line of authority that powers under a pension arrangement can be operated by a trustee in bankruptcy, notwithstanding the protections under the Pensions Act 1995. Most recently at the tail end of 2014, the English High Court in Horton v Henry did not follow Raithatha and held that a bankrupt’s pension which had come into payment could not be subjected to an income payment order under the [English] Insolvency Act 1986. This may be seen as creating an anomaly between drawn and undrawn rights, but different provisions were under consideration. The Henry case might be seen as more in sympathy with those anti-bankruptcy pension protections in the 1995 Act.

So the net effect of the introduction in 2015 of the right of total commutation (subject to marginal rate income tax) may well lead to a bonanza for the trustee in bankruptcy of any bankrupt who has undrawn pension savings. We will be keeping a close eye on developments and will report as and when cases arise.

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

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