Insolvency options and the treatment of disability benefits

In every debt case advisers need to consider their client’s income and expenditure and assess their surplus income in order to give advice about suitable options for dealing with their debts. This article will consider how disability benefits such as Personal Independence Payment (PIP), Disability Living Allowance (DLA) and Attendance Allowance (AA) are treated when assessing the client’s surplus income and whether this might differ depending on the insolvency option they choose.

Each of these benefits is intended to meet the additional costs of disability related needs. Research undertaken by Scope found that in 2023 disabled people paid on average £583 per month more on essentials. The Resolution Foundation has also reported that disabled clients are even more likely to have a negative budget than those without disabilities.

Having said that, an assessment of surplus income must still be done and advisers need to know how to treat income from disability benefits when making that assessment. Surplus income is assessed for slightly different reasons for each of the three formal insolvency options that we’ll look at in this article:

Bankruptcy — For bankruptcy the Official Receiver examines income and expenditure and assesses surplus income only after the order is made, to work out whether the client can make contributions to their bankruptcy. If they can, the client will need to make payments under an income payment order or agreement (IPO or IPA) for three years. Advisers will need to consider how surplus income is assessed in bankruptcy when discussing the suitability of this option with a client.

Individual voluntary arrangement (IVA) — For an IVA the client will need a regular income with a reasonably good surplus to make an IVA a suitable option. The Insolvency Practitioner will assess the client’s surplus income to determine the amount that can be offered to creditors under the IVA proposal. In most cases monthly payments are required for at least 5 years. If available income goes up during the IVA term the client will be asked to pay more into the IVA.

Debt relief order (DRO) — A client will only be eligible for a DRO if they have no more than £75 per month surplus income. Advisers will need to assess this to check whether a DRO is available to them. No payments are required once the order is made, however if income goes up during the DRO moratorium this will need to be reported and the DRO could be revoked.

When it comes to the treatment of disability benefits each of these debt options has different guidance. However, for all three options debt advisers (and the Insolvency Service) will use the Standard Financial Statement (SFS) as a tool to determine the client’s income, essential expenditure and surplus income.

The standard financial statement includes guidance for users which looks at the treatment of disability benefits.

Standard Financial Statement User Guide

Para 3.13: ‘Disability Living Allowance (DLA), Attendance Allowance (AA) or Personal Independence Payment (PIP) should be included under the ‘Disability Benefits’ field in ‘Benefits and tax credits’. Advisers should add a note to explain the amount paid under each allowance / payment and may wish to add a note to explain if both mobility and care components are awarded’.

Para 3.14: ‘The intention behind these payments is that they will be used for specific disability costs and related expenditure should be recorded as appropriate. Disability related expenditure should be listed under ‘adult-care costs’, while expenditure relating to mobility needs should be included within the ‘transport and travel’ category. However, it should be noted, clients may also choose to use DLA, AA or PIP payments to repay debt, where appropriate’.

FCA requirements — the client’s financial statement should accurately reflect their income and expenditure

Debt advice is regulated by the Financial Conduct Authority (FCA) and advisers must comply with FCA rules and guidance found in the Consumer Credit Sourcebook — CONC.

CONC 8.5 ’A firm must ensure that a financial statement sent to a lender on behalf of a customer: (1) is accurate and realistic and must present a sufficiently clear and complete account of the customer’s income and expenditure, debts and the availability of surplus income’

So in order to comply with requirements of the FCA under CONC 8.5 advisers need to produce for each client a financial statement which accurately reflects their income and their actual expenditure.

Citizens Advice SFS guidance says that ‘how PIP is treated within the SFS, can depend on a number of factors, such as how the client uses that money, and what options they are considering. The adviser needs to explore and record the client’s actual expenditure on the costs of their disability in order to get a complete picture unless it is impractical to do so. Client’s may use their PIP towards their bills/living costs, and if so, this should be reflected within the budget, and not automatically off-set. ‘

Advisers will also need to record the client’s income from all sources in order to meet the requirements in insolvency legislation.

Every payment in the nature of income

For both DROs and bankruptcy, the legislation sets out that the client’s ‘income’ includes ‘every payment in the nature of income which is ‘from time to time made to them or to which they from time to time become entitled’. [Reg 9.7 (1) Reg 9.7 (1) Insolvency (England and Wales) Rules 2006 and S310 (7) Insolvency Act 1986].

It is therefore clear that under the legislation, income from disability benefits must be included as income in any assessment of surplus income, along with income from all other sources.

Reasonable domestic needs

For both the qualifying conditions for a DRO and calculation of an income payments order or agreement in bankruptcy, the legislation says that to work out the client’s surplus, an amount to cover the ‘reasonable domestic needs’ of the client and their family can be deducted from their income. [Reg 9.1 (2)Insolvency (England and Wales) Rules 2006 and S310 (2) Insolvency Act 1986].

There are no specific rules about which income or expenditure should be taken into account to work out the monthly payments into an IVA. However the IVA protocol, which covers most simple consumer IVAs, suggests that the standard financial statement should be used [Para 6 2021 version].

Calculating surplus income in bankruptcy

The purpose of assessing surplus income for bankruptcy is to determine whether the client will need to make contributions to their bankruptcy in the form of a three year income payments order or agreement [s310 IA 1986]. Where the bankrupt has surplus income an IPO or IPA can be made for the full amount of that surplus.

Since April 2017 official receivers will calculate surplus income using the Standard Financial Statement (SFS). The SFS will be used ‘as a first step in any assessment’ [Technical Guidance for Official Receivers 35.2]

“Income” for the purposes of an IPA or IPO is widely defined under section 310(7) as any form of income. The Technical Guidance for Official Receivers provides guidance on the position where the client’s only income comes from state benefits.

35.28 ‘There is nothing in legislation which excludes state benefits, once paid to the individual, from falling within the definition of “income” [section 310(7)].

As a matter of policy, an IPA (or IPO) should not be sought where the bankrupt’s only source of income is state benefits.

In this context “state benefits” refers to all forms of income supplement and support provided by central or local government including payments of a War Disability Pension (Naval, Military and Air Forces Etc. (Disablement and Death) Service Pensions Order 2006, where the bankrupt has been injured on active service, these should be regarded as a state benefit. There is no requirement to undertake an assessment of surplus income where the only source of the bankrupt’s income is state benefits. In all other cases an assessment should be made even if part of the household income is derived from state benefits.’

So if the client’s only income is benefits (which may include disability benefits) there will be no assessment of surplus income. However if the client has some benefit income and some income from another source, an assessment of surplus income will be carried out — ‘the reasonable domestic expenses should be deducted from this total income to establish the surplus income’ [35.29 Technical Guidance for Official Receivers].

In this situation, an IPA or IPO may be made as long as it’s not for more than the amount of income that the bankrupt gets from non benefit sources. ‘It should be remembered that whilst the bankrupt’s total income (including state benefits) can be included in the calculation of surplus income, it is the income from sources other than the benefit(s) which is providing the payments under the IPA.’ [35.29 Technical Guide for Official Receivers].

This means that where a client is in receipt of, for example PIP and part time earnings the official receiver will assess their surplus income by taking into account their whole income (the PIP is not ignored), but the amount of any IPA will not be more than the income from their part time earnings.

Case example — Isla is 70 and lives with her son who is her carer. Her monthly income is £1,312 including:

Attendance Allowance — 441

State Retirement Pension — 677

Pension Credit — 153

Private pension — 41

As Isla has no housing costs her monthly essential expenditure is £1,232, giving her a surplus of £80 per month.

If Isla chooses bankruptcy any IPA will be limited to £41 per month (her private pension income) as it cannot be taken from her benefit income. The IPA will last for 3 years.

The total cost of bankruptcy for Isla will be £1,476 plus the £680 fee — £2,156

Calculating surplus income for an IVA

An insolvency practitioner is required by the legislation to submit a proposal for the voluntary arrangement which has ‘a reasonable prospect of being approved and implemented’ [s256A IA 1986]. The proposal itself must ‘explain why the debtor thinks an IVA is desirable’ and ‘explain why the creditors are expected to agree to an IVA’ [Rule 8.2 Insolvency (England and Wales) Rules 2016]. However the legislation does not include rules specifying how the client’s income and expenditure should be assessed to arrive at the proposed monthly payments.

The IVA Protocol is a voluntary agreement which gives a standard framework for dealing with straightforward consumer IVAs and provides guidance to insolvency practitioners. The Protocol (which is regularly updated) sets out some general principles. Clause 2 of the 2021 version of the IVA Protocol states that:

‘Where the consumer’s income is solely made up of benefits or state pension, an IVA is very unlikely to be a suitable solution for the consumer; however, if an IVA is to be proposed in these circumstances, the reasons why it is considered suitable should be clearly documented in the proposal (see clause 6.6)’.

Clause 6 -

‘The income and expenditure statement should be forward-looking (for the duration of the IVA) and in line with the Standard Financial Statement (SFS) approved by the Money and Pensions Service. Generally, there should be no deviation from the expenditure parameters in the SFS but where there are (for example, due to factors such as any health issues, caring duties or above average work-related travel costs) this should be clearly explained in the proposal, any subsequent reports to creditors and documented on the IVA file.’

‘The consumer’s income and expenditure must be a realistic reflection of their financial position and at levels that are considered to be reasonably likely to be sustainable over the duration of the IVA. The consumer’s income, expenditure and monthly contribution to the IVA must be such that this will not cause any undue hardship to the consumer.’

‘6.6 Any state benefits, including those relating to income (universal credit, child benefit and pensions, etc) and also ill-health, disability or caring responsibilities should be included as income. The insolvency practitioner should ensure that any caring related costs are also included as an expense within the relevant section of the SFS.’

The calculation of surplus income will include PIP, AA and DLA in full as income and any care and other disability costs should be deducted as essential expenditure. In contrast to the guidance in bankruptcy there is nothing in the IVA protocol to suggest that monthly payments into the IVA cannot be derived from state benefits.

Case Example — In Isla’s case her SFS shows that she has £80 per month surplus.

If Isla chooses an IVA she will be expected to pay the full amount of this into her arrangement. The IVA will last for 5 years.

The total cost of an IVA for Isla will be — £4,800.

Calculating surplus income for a DRO

The Insolvency Service DRO Team recognises that disability benefits are intended to cover the extra costs of disability and has agreed that when assessing surplus income for a DRO ‘on-going payments of PIP, DLA and AA can be offset under adult care costs’ - Debt Relief Order: Guidance for Debt Advisers.

In order to comply with the requirement that income includes ‘every payment in the nature of income received by the client,’ advisers must always include the full amount of any benefits that they receive as income. However when it comes to expenditure, the Debt Relief Order: Guidance for Debt Advisers will apply so that the full amount of any ongoing payments of these benefits can then be offset in the expenditure column. This effectively cancels out the whole of the payment so it doesn’t come into the calculation of the client’s surplus.

There’s arguably a conflict between the requirement that a client’s financial statement must accurately reflect their income and expenditure and the Insolvency Service Guidance contained in DRO: Guidance for debt advisers that ‘the full amount of any PIP/DLA/AA received can be offset as ‘adult care costs’ when assessing surplus income for a DRO’.

It’s important to note that the surplus income calculator for a DRO is used to assess the client’s eligibility for a DRO and not for making offers of payment to creditors. CONC 8.5 refers to statements sent to lenders.

It’s also relevant to note that under FCA regulation advisers must always act in the client’s best interests. With the new FCA consumer duty debt advisers are also required to ‘act to deliver good outcomes’ for clients.

At Citizens Advice we’ve concluded that where surplus income is being assessed for a DRO the Insolvency Service guidance to offset the full amount of the benefit received should be followed as long as it’s in the client’s best interests.

Case example — Isla’s disability related expenditure is £400 per month. Following the DRO: Guidance for debt advisers, the approved DRO intermediary can offset the full amount of her attendance allowance of £441 as adult care costs when assessing her eligibility for a DRO.

This means that her surplus income for DRO purposes is £39 a month and she is eligible.

If Isla chooses a DRO the order will last for 12 months and she will not need to make any repayments.

The total cost of a DRO for Isla will be — £90 (the DRO fee).

It will be up to Isla to choose the option that will deliver the best outcome for her.

At Citizens Advice we’ve worked with our debt quality team to produce some guidance on offsetting disability benefits in a DRO. The guidance applies to Citizens Advice approved intermediaries and debt advisers. If you are not a Citizens Advice intermediary check with your Competent Authority.

We suggest that when you are assessing a client’s surplus income for a DRO and they are in receipt of DLA or PIP:

• In every case you need to explore and record the client’s actual expenditure on the costs of their disability in order to get a complete picture of their income and expenditure unless it’s impractical to do so.
• When a DRO is being explored it’s acceptable to offset the full amount of the benefit received as expenditure when calculating surplus income, even if the client doesn’t spend this much.
• If this results in a negative budget, a DRO application can still be made, but a note should be included in the client’s case notes to explain the reason for the negative budget i.e. that it’s in deficit because the DRO guidance on offsetting has been applied.
• Where the full amount of benefit has been offset as expenditure, be careful that further amounts are not included in other expenditure for the costs of the disability, for example increased travel or energy costs.
• If the amount that the client spends on care and other aspects of their disability is more than the amount of PIP, AA or DLA that they receive, you should include the actual amount that they spend instead of offsetting.
• You can choose to include details of the client’s expenditure instead of offsetting but should not do both in order to avoid double counting.
• Any figures scheduled in a DRO application or decisions to include or omit information must be capable of standing up to scrutiny if the application is subsequently queried by the DRO team.
• In some cases, it might be appropriate to keep 2 financial statements on file — one for the DRO application and one for the client.

Lorraine Charlton works as a debt expert in the Expert Advice team at Citizens Advice

The information in this article is correct as of the date of publication

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