Taking pension benefits early through ill health
Normally people have to wait until age 55 before they can access their pension benefits. There are a few notable exceptions to this rule, and one of these is taking benefits early due to ill health.
There are two sets of circumstances for taking benefits early through ill health. The first is early retirement where the individual cannot carry on working (usually) in their occupation; the second is taking all benefits early due to serious ill health where they are not expected to live for more than a year. This article covers both of these.
The rules surrounding ill health benefits aren’t particularly complicated. How the rules are interpreted and applied often depends upon the pension scheme’s rules, however, so it’s worth checking with the scheme administrator how ill health requests are treated in that particular scheme.
Scheme administrators have to include details of all ill health cases on their quarterly tax returns to HMRC. Because of this high visibility, they are naturally keen to make sure all the i’s are dotted and the t’s crossed, in case HMRC decides to challenge them on case details.
Early retirement through ill health
An individual can take their pension benefits before the age of 55 if, due to ill health, they are unable to carry out their current occupation.
However, it’s worth noting that some schemes’ rules are stricter and will require the individual to be incapable of carrying out any occupation, not just their current one.
A lot can hinge on the word ‘occupation’. For example, take someone who has founded a company, is a major shareholder, and then becomes ill and is unable to return to their job of managing director full-time. Instead they return as a non-executive director working fewer hours. HMRC might argue they are performing effectively the same job as before (just for a shorter time period) and still in the same occupation.
Scheme administrators may want proof the individual has left their previous occupation, such as a copy of the P45 form. However, if the individual is carrying on working for the same company in some other capacity, then the scheme administrator may want robust evidence to back this position. If someone transfers to a new provider whilst taking benefits early through ill health and has already stopped working, then the new scheme administrator may want to know what the individual’s previous occupation was and what work, if any, they are doing now.
Medical and other evidence
When granting requests to take benefits early due to ill health, scheme administrators need to have written evidence from a registered medical practitioner that the client is unable to return to their current employment.
Different providers and scheme administrators will have different requirements and forms to complete, so it’s best to check what the scheme may want or need beforehand. Getting the right information for the scheme will mean being able to present a full case to the scheme administrator the first time – rather than going back to the client to ask for further information. As the client is in ill health, they probably wouldn’t appreciate several requests for details and evidence.
The medical practitioner has to be a fully-registered person within the meaning of the Medical Act 1983. However, this isn’t always a straightforward requirement to meet. Over the past few years we have seen the rise of online medical services, where someone can consult with a General Medical Council (GMC) registered doctor by video or text chat.
Sometimes people may ask to take early retirement ill health benefits following an online consultation. Usually the person requesting ill health benefits would have already had several medical appointments over the past few weeks and months, if not years. So it seems strange to request payment of benefits following an online consultation, and scheme administrators will probably want to investigate the circumstances further.
There are also cases where the medical evidence is signed by a medical practitioner who works overseas. Again, in these sort of cases, the scheme administrators will investigate further to make sure the overseas qualifications are robust enough.
What benefits can be paid out through early retirement?
If it is a money purchase scheme, then the benefits paid out on early retirement through ill health will be subject to what the scheme will allow. For example, tax-free cash plus flexi-access drawdown or an uncrystallised funds pension lump sum (UFPLS) or an annuity. Someone taking tax-free cash, then designating the rest of their pension fund to flexi-access drawdown, could withdraw the whole remaining amount. It would, though, be subject to tax.
If someone decides to only partially crystallise their money purchase benefits and then subsequently take another chunk, it’s worth investigating how the scheme will view this. Some scheme administrators will allow a further crystallisation with no more checks; others may want to see updated evidence that the individual cannot carry out their current occupation.
For a defined benefit scheme, the scheme rules will determine the basis of the calculation of benefits and what, if any, reduction of benefit applies. If there is a guaranteed minimum pension (GMP) included, then this can only be paid out where the revalued GMP promise is covered.
Normal pension taxation rules will apply to any early retirement benefits, and benefits will be tested against the full lifetime allowance (unlike when someone takes benefits at, or after, their protected pension age of lower than 50 where the lifetime allowance is reduced by 2.5% for each complete year between taking benefits and the age 55).
If an individual recovers from their illness, then it’s worth checking the scheme rules on whether the ill health payments will stop. An occupational pension scheme’s rules could set out that on recovery, the scheme pension will stop and the client has to wait until age 55 before the payments can recommence.
There is no HMRC requirement to assess ill health on an ongoing basis, so if the client did recover and reassume work, it shouldn’t necessarily invalidate earlier benefits (unless the scheme rules dictate otherwise).
Serious ill health
If someone is in serious ill health, then they should be able to access their pension benefits as a serious ill health lump sum at any age.
There are four main requirements the scheme administrator and member have to meet:
1. the member has to have written evidence from a registered medical practitioner that they have less than 12 months to live;
2. the pension benefits must be uncrystallised;
3. the payment of the benefits has to extinguish all uncrystallised rights; and
4. the member has to have some unused lifetime allowance.
Again, it’s worth checking with the scheme administrator what forms and evidence need to be completed, as different schemes will have different forms and requirements. If the person is in serious ill health, then they will want their benefits quickly and without fuss.
Unlike early retirement through ill health, the member cannot take part of their benefits at one time, and then crystallise the remaining amount a few months later. They have to take all uncrystallised benefits together.
Taxation and the lifetime allowance
How the serious ill health lump sum is taxed and tested against the lifetime allowance depends on the age of the member.
If they are younger than 75, then the payment of a serious ill health lump sum is a benefit crystallisation event (BCE6) and is tested against the lifetime allowance. They have to have unused lifetime allowance to be able to take a serious ill health lump sum, but the amount of lump sum paid is not limited by how much lifetime allowance they have left. If there is an excess, then it is taxed at 55%. The scheme administrator deducts the lifetime allowance charge before paying the lump sum. The payment isn’t subject to income tax.
If the member is 75 or over, then the member’s uncrystallised pension benefits would have already been tested against the lifetime allowance at age 75. However, for working out whether the member has any lifetime allowance left (and so is allowed to take a serious ill health lump sum), any lifetime allowance used up in the age 75 tests is ignored. The lump sum will be taxed at the client’s marginal rate of income tax.
Any payment paid out under early retirement due to ill health is subject to income tax, but this would be tax-free if paid out under the serious ill health rules. This has led to suggestions that some people may prefer to put off taking pension benefits due to ill health until they receive a serious ill health diagnosis.
Crystallising less in ill health leaves more uncrystallised funds that would potentially be paid tax-free under serious ill health rules. However, this would probably be a much more complicated decision. The decision would depend upon, amongst other things, the expected time between the two diagnoses and, crucially, if the member needed the money before, for example to help them make adjustments in their lifestyle due to their illness.
Knowing how and when to access pension benefits due to ill health is an important part of helping clients with crucial changes in their life. Although there are general principles and rules on how to access benefits early due to ill health, how it will work in practice often depends upon the individual scheme rules, and it’s worth understanding how the scheme operates and what evidence it requires – and in what form – before it will make a decision whether to pay out benefits early.