This guide is for financial advisers only. It must not be distributed to, or relied on by, customers. The information on this page is based on our understanding of legislation as at May 2023.
Bankruptcy is a legal process and is usually the option of ‘last resort’ when someone can’t pay their debts. Although different legislation applies in England and Wales, Northern Ireland and Scotland, the broad principles are the same. Bankruptcy involves the transfer of an individual’s assets into the hands of a trustee in bankruptcy (the ‘trustee’) for the benefit of the individual’s creditors. The bankruptcy proceedings will be initiated by either an individual applying to be made bankrupt or by one or more creditors presenting a bankruptcy petition to court. In either situation, a court will decide whether to issue a bankruptcy order depending on the facts of the case. However, in Scotland, the Accountant in Bankruptcy, an agency of the Scottish Government, can declare an individual bankrupt.
The trustee will be an official receiver (who is an officer of the court), the Accountant in Bankruptcy (in Scotland) or a licenced insolvency practitioner. It falls on the trustee to carry out certain duties relating to the bankruptcy. Generally, this will involve collecting information relating to the bankrupt’s financial affairs, disposing of assets held and making payments to creditors. Some assets can be protected, for example clothing, bedding, and furniture. It may also be possible to protect tools and vehicles necessary for the bankrupt’s employment or business.
Usually, a bankruptcy is automatically discharged after 12 months. However, the bankruptcy period may be extended if, for example, the bankrupt hasn't co-operated with the trustee.
Discharge means that a bankrupt is freed from the restrictions of bankruptcy and released from most of the debts they owe. It does not mean that they will automatically regain control of any remaining assets. The trustee could continue to administer the assets which formed the bankruptcy estate, including assets which may not be realisable until sometime in the future (for example, an endowment policy). Similarly, an income payments order or agreement requiring a bankrupt to make payments from their income towards their debts may continue beyond the date of discharge.
Anyone being made bankrupt benefits from statutory protection that applies to most pension funds. This protection was introduced by the Welfare Reform and Pensions Act 1999 and means that a trustee cannot access the funds whilst they remain in a registered pension scheme such as an occupational scheme, a personal pension, a S226 retirement annuity or a S32 buyout policy. In practice, if the bankruptcy trustee is advised that a pension fund is held in a registered pension scheme, they should acknowledge that the fund does not form part of the bankruptcy estate.
The position is different where a benefit is being paid from a registered pension scheme during the bankruptcy period (usually 12 months, as outlined in the previous section). An income payments order (IPO) may be put in place under which some or all of the benefit is paid to the trustee instead of to the bankrupt. In Scotland, the equivalent is a debtor contribution order (DCO). An IPO or DCO would usually only be put in place where the bankrupt’s total income was in excess of the income they and their family could reasonably be expected to live on.
Usually, a pension arising from contracted-out service can be taken into account when calculating the bankrupt's income but cannot itself be subject to an IPO or DCO. However, a pension which came into payment on or after 6 April 2012 arising from former protected rights (under money-purchase contracting out) can be subject to an IPO or DCO.
An IPO lasts for a maximum of three years and a DCO for a maximum of four years, so can continue beyond the discharge of the bankruptcy.
If a bankrupt’s pension rights are held in a scheme that is not a registered pension scheme, then the rights automatically transfer to the trustee. However, the rights held can be excluded from the bankruptcy estate if the bankrupt applies to the court for an ‘exclusion order’ or if a ‘qualifying agreement’ is made between the trustee and the bankrupt. Regulations set out the requirements and procedures, including time limits, which must be met if the exclusion is to apply.
Pension contributions can continue to be paid by the bankrupt during the period of bankruptcy, although the trustee may need to agree to this. The trustee may decide that money used to make personal contributions should, instead, be used to reduce the bankrupt’s debts. However, personal contributions made as a condition of the bankrupt’s employment (e.g., contributions to an occupational pension scheme or a group personal pension scheme) are unlikely to be affected and can usually continue to be paid. Any pension contributions by an employer can continue to be made.
Generally, investment decisions can continue to be made in the same way as before an individual was declared bankrupt. As the funds in a registered pension scheme do not form part of the bankruptcy estate, the trustee has no interest in them. The bankrupt should continue to make decisions on where their pension funds are invested.
If an individual has been deliberately putting money into a pension arrangement in order to put it beyond the reach of their creditors, a trustee can apply to the court for a ‘restoration order’. The restoration order would require the pension scheme trustees or administrator to pay to the trustee any contributions deemed to be excessive.
It is up to a trustee to show to the court that any contributions were excessive, taking into account the bankrupt’s circumstances when the contributions were paid and whether creditors were unfairly prejudiced or not. Additionally, the order can provide for the pension scheme trustees or administrator to recover costs that they incur in either providing any necessary information or in implementing the order itself.
There are also special rules that apply to pension sharing on divorce cases. In very limited circumstances, it’s possible for a trustee to recover excessive contributions that were made by a bankrupt before a pension sharing order was made. The recovery would be made from the pension credit granted to the ex-spouse.
As mentioned above, if an individual is made bankrupt, pension funds in registered pension schemes don’t form part of the bankruptcy estate. This protection applies to individuals made bankrupt as a result of a petition made on or after 29 May 2000. If the petition for bankruptcy was made before 29 May 2000, the position depends on the circumstances of each case. Individuals petitioned for bankruptcy before that date will, in the vast majority of cases, have had their bankruptcy discharged after three years. However, it may still be possible for the trustee to claim benefits coming into payment now from pension funds which existed at the time the individual was made bankrupt.
If the funds were in an approved occupational pension scheme, they are likely to be protected from claims by the trustee. Many approved occupational pension schemes contained a forfeiture clause under which, if a member became bankrupt, benefits were forfeited; consequently, there was nothing for the trustee to claim. Forfeited benefits fell to the pension scheme trustees to be paid at their discretion and they could choose to pay benefits on retirement to the member or to the member’s dependants.
Some approved personal pension schemes also contained a forfeiture clause which operated in a similar way. If there was no such clause, the pension funds formed part of the bankruptcy estate and benefits payable from those funds could be claimed by the trustee.
Individual contracts, such as S226 retirement annuity contracts and S32 buy-out policies, did not contain a forfeiture clause. As they are individual contracts, there are no pension scheme trustees to exercise any discretion as to who should receive the benefits.
Where pension funds form part of the bankruptcy estate, the trustee can generally only claim the benefits to which the member was entitled, and at the age at which the member could take them. For example, if someone aged 25 had been made bankrupt in 1995 and had a S32 buy-out policy, the trustee would have to wait until 2025 – when the individual reaches age 55 – before being able to claim any of the pension benefits. If the outstanding debts had been paid off by that date, the trustee would have no further interest in the policy and ‘ownership’ would pass back to the individual.
You can find out more about bankruptcy, and the alternatives to bankruptcy, on these websites: