Lisa Webster: Beware the unintended consequences of pension freedoms

George Osborne’s announcement that “pensioners will have complete freedom to draw down as much or as little of their pot as they want, anytime they want” was widely welcomed and indeed accepted as good news for many with defined contribution pensions.

However, now the freedoms are here there are a growing number of scenarios where the news is not all good. Two situations in particular stand out where some may be worse off under the new regime.

First, we have the case of someone who is struggling to pay their debts but is over the age of 55. Historically the Welfare Reform & Pensions Act 1999 protected pensions and meant a trustee in bankruptcy could not make a claim against the pension. The position changed slightly following the high court ruling in Raithatha v Williamson in 2012. It was held that, as the member was over 55, the trustee could force the bankrupt to take their maximum income under capped drawdown and pay it to them.

Things changed again last year with another high court case, Henry v Horton, with the judge’s ruling contradicting the Raithatha case – in effect meaning the pension was again treated as being protected. This case is going to appeal and is expected to be heard by the end of the summer.

With this in mind, you might be forgiven for thinking there is a good chance (if the decision is upheld) of pensions being protected going forward. However, let’s take a look at a case study and see what might happen.

Case study one: Declaring bankruptcy

Mr Jones is 58 and a bit of an entrepreneur. He has had a number of businesses over the years and built up a pension pot of £200,000. However, his current venture has not gone to plan and he owes creditors £100,000. When he set up the business he used some loans he personally guaranteed. Mr Jones has spent all his available resources and now only has his pension left.

He has not taken any income from his pension and his intention is to continue working for a few years yet. He recalls being informed by a financial adviser a few years ago that pensions are protected in the event of bankruptcy. As he has no other means of paying his creditors Mr Jones files for bankruptcy.

The court rejects Mr Jones’ application on the basis he can access his pension to pay the debts. They do this under section 251C of the Insolvency Act 1986, as the official receiver must be satisfied the debtor is unable to pay their debts or they are obliged to refuse the application.

In practice this means the recent rulings (and outstanding appeal) are irrelevant: anyone over 55 can access their whole fund and may be forced to use this to pay debts before they can get to the point of declaring bankruptcy. And to put a sting in the tale, because pensions have been flexibly accessed, if Mr Jones does get back on his feet and his next business is a success, he will be restricted to putting £10,000 a year into money purchase pensions with no carry forward available.

Case study two: Means-tested benefits

The second scenario relates to those on means-tested benefits who make use of the pension freedoms.

Under the new rules anyone over pension credit qualifying age has a notional income for means-testing purposes of the higher of the income they actually withdraw or 100 per cent of the annuity they could purchase, based on Government Actuary’s Department tables. Any one-off withdrawals are treated as capital.

Let’s take the case of Mrs Brown, who is 65 and has a small personal pension fund of £10,000.

Mrs Brown has a personal loan of £3,000 that she is paying off monthly and that will not be paid off in full for another two years. As she now has unlimited access to her pension, she decides to withdraw £3,000 net as a lump sum in order to pay off the loan in full.

When Mrs Brown speaks to the Department for Work and Pensions regarding her means-tested benefits she is shocked to discover that using the £3,000 to pay off the loan has been treated as deliberate deprivation of her capital as the loan was not in default, so did not need to be urgently repaid. This has an impact on the means-tested benefits she can receive.

The effect on means-tested benefits of using capital from pensions to repay non-urgent debts is not cut and dry as it is down to the decision maker at the DWP. It will look at things on a case-by-case basis but it is certainly a risk to consider.

Lisa Webster is technical resources consultant at AJ Bell

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