In most circumstances pensions can only be accessed once the member has reached normal minimum pension age (NMPA). This is currently age 55 but as has been widely publicised (in the industry at least), will be rising to age 57 from 6 April 2028. This change will lead to yet more people having a protected retirement age that is different to the NMPA, on top of those with a protected age courtesy of the last rise from 50 to 55 in 2010, and not forgetting any sportspeople or performers who had a protected retirement age from before A-day.
Putting these protected ages aside, most people can only take benefits before NMPA if they qualify for early access on health grounds. The criteria for this early access, the form of benefits that can be taken, and the tax implications, are the subject of this article.
There are two types of early access to pensions on health grounds. These are ill-health and serious ill-health. With an increase in the normal age for accessing benefits, there will be a natural uptick in people needing access under ill-health rules who would previously have been over NMPA.
Members may be able to access pensions at any age if they meet the ill-health condition. The minimum requirement for this is that the scheme administrator has been provided with evidence that the member is, and will continue to be, medically incapable of continuing their current occupation due to injury, sickness, disease, or disability, and that they have ceased that occupation.
The definition does allow for the nature of the incapacity to be physical or mental and the evidence must be provided by a registered medical practitioner.
Although this is the minimum requirement, it is important to note that some schemes may have stricter ill-health criteria written into their scheme rules. Most commonly this would be to state that the member must be incapable of carrying out any occupation, rather than just their current occupation. For example, someone in a manual job may be unable to continue due to permanent physical injury but be perfectly capable of carrying out a desk job. Whether or not their pension scheme would allow early access will depend on whether their scheme rules use the “current occupation” or “any occupation” definition. It is also worth noting that different schemes may have different requirements in terms of the evidence they will accept – for example some may insist on a medical examination.
Once the medical evidence has been accepted and the member has ceased the relevant occupation, benefits can be taken. The options available under the scheme will be the same as if they have been accessed at normal retirement age.
Benefits taken early under ill-health will be taxed in the usual way – i.e. 25% of funds crystallised can be taken as tax-free pension commencement lump sum (PCLS) up to the lifetime allowance, with the balance used to provide a taxable income, or 25% tax-free/75% taxable uncrystallised funds pension lump sum(s) (UFPLS) can be taken. It is also worth noting that, unlike with some protected pension ages, there is no reduction in the lifetime allowance available due to taking benefits earlier.
It is also possible for benefits taken early under ill-health to stop if the member recovers and returns to work. This would be unusual as to meet the criteria at outset they have to have been deemed medically incapable of working on a continuing basis – however the rules do allow for recovery and recognise that the prognosis can change. Under these circumstances the recovery does not make the benefits already taken unauthorised so no penalty will apply provided the condition was met at the time benefits were first paid out. Neither does recovery itself mean benefits must cease – although some scheme rules may – as the test is a one-off at the time benefits are crystallised.
It is worth noting though that taking any income under flexi-access drawdown or taking an UFPLS will trigger the money purchase annual allowance (MPAA) so the ability to rebuild funds on returning to work will be reduced.
One area where you do need to be careful with those in receipt of ill-health pensions is on transfer.
Take the example of a client who is unable to continue in their current full-time high-stress occupation at the advice of their doctor. However after a break to recuperate, they want to do something completely different and move to a more relaxed low-key part-time job in a different field. In these circumstances they may want to access some of their pension (especially if they have substantial savings) to top up their significantly reduced income. Provided their pension scheme rules allow the maximum flexibility, meaning they can access benefits when they stop their original occupation, then they can take early ill-health pension. If they later start work in their new occupation then that pension can continue.
If you decide with the client that it is appropriate to transfer the pension to a new provider, for whatever reason, then you need to be careful with the timing. If a transfer is carried out before the client stops their original occupation, or when the client is not working at all, then the ill-health condition will be satisfied (assuming appropriate medical evidence is provided). If you transfer once the new occupation has begun, then the client will no longer qualify under the ill-health rule as at the point they join the new scheme that new occupation becomes the occupation that they have to be incapable of carrying out.
The serious ill-health condition is only met when a client has been given the clinical prognosis of less than twelve months to live. It can be paid at any age, and where this condition is met then the whole fund can be withdrawn as a lump sum. Clearly this option is also available under the ill-health condition, or for anyone who has reached NMPA, as under normal benefit rules you can take the whole fund as a UFPLS or take maximum PCLS and withdraw everything under flexi-access drawdown. However, the big difference is that a serious ill-health lump sum is completely tax-free up to the lifetime allowance when paid before the age of 75. Technically it can be paid after the 75th birthday but it is taxable as income so there is little benefit in accessing the pension in this way over the usual methods.
Where the lifetime allowance is exceeded then the lifetime allowance charge at 55% will be payable on the excess. In practice the scheme administrator would deduct this before paying the sum to the member.
Two key points to remember about serious ill-health lump sums are that:
- they can only be paid from uncrystallised funds, and
- all funds under that arrangement must be distinguished.
This means that you cannot partially crystallise funds to take a serious ill-health lump sum. Of course, as funds are uncrystallised you could do a partial transfer of the amount you wish to crystallise (or the amount you wish to leave untouched), to separate out the amount you wish to crystallise, and achieve the same result.
Taking a serious ill-health lump sum is probably only going to be the right thing for the client if they have an immediate need for the cash, or at least are not going to exceed the nil rate band for inheritance tax. Withdrawing the cash from their pension when they are terminally ill is unlikely to be the best option if the money is just going to increase the size of their estate for inheritance tax purposes.
Ill health to serious ill-health?
It is likely that most clients who have health problems will first think about accessing their pension before they reach the serious-ill health stage.
This could happen at any age – be it accessing pensions early under the ill-health provision, or just those in the late 50s or 60s stopping work whose chances of making it to age 75 are reduced.
Clearly each client’s financial circumstances will be different. For those that have other available assets leaving the pension untouched and therefore outside the estate is the obvious choice.
However, for those less financially fortunate it may be worth crystallising as little as required when taking benefits for the first time. So you could consider either taking UFPLS payments or maximum income under flexi-access drawdown to meet the immediate income needs. This would leave a larger proportion of their fund uncrystallised so that if their condition worsens their remaining funds would be uncrystallised and could still qualify under the serious ill-health lump sum rules so be paid out tax free in their final year.
Even those with reasonable financial provisions may suddenly have substantially higher income requirements at this time. This could be for private care to make their final days more comfortable, to help them complete their bucket list, or even to pay for pioneering private treatment not otherwise available that may potentially extend their life. Having funds available tax-free may be a big help.
These will be tough times for your clients and their families but getting the advice right and keeping their options open as their circumstances change can help make things a little easier.
This article was previously published by FT Adviser
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