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Pensions advice for clients with Ill-heath or serious ill-health

6 July 2020

Greg Kingston, Group Communications director at Curtis Banks, uses some  practical case studies to explain the difference between with ill-heath and serious ill-health in respect of advising on pensions

When providing advice, one of the most difficult situations can be dealing with a client that has been diagnosed with ill-health or serious ill-health.

In pension terms, clients are considered to be in ill-health if they are, and will continue to be, medically incapable of continuing to do their occupation and they have stopped working in their occupation. This must be confirmed by a registered medical practitioner.

There is a slightly different definition of serious ill-health which is deemed, in pension terms, to be a client where a registered medical practitioner has confirmed that he or she is expected to live for less than one year.

A client that meets the ill-health condition can access his or her pension benefits before normal minimum pension age (currently 55) without incurring the normal tax penalties for doing so.

Pensions accessed early due to ill-health are treated in the same way as those accessed from normal minimum pension age. For example the client would be entitled to a pension commencement lump sum (PCLS, also known as tax-free cash), the funds accessed will still be tested against the individual’s lifetime allowance and income payments will still be subject to income tax.

But not all pension schemes have the same flexibility around ill-health and so advisers need to carefully review the scheme rules for any client. The most common variation is a requirement for individuals to be medically incapable of undertaking any occupation, rather than just their own.

Let’s take a look at some examples of how this all works in practice.

Linda, aged 53, is a secondary school PE teacher who has been saving for her pension for the past 25 years. She has accumulated a pension pot of over £100,000.

Due to an unfortunate illness, a registered medical practitioner has said that Linda is medically incapable of continuing in her occupation.

In usual circumstances, accessing a pension under the minimum pension age of 55 would result in heavy tax penalties. However, as Linda has been deemed to be in ill-health, if she accesses her pension early, it will be treated the same as if she accessed her pension at the normal minimum pension age of 55. This means that:

  • Linda will be entitled to a pension commencement lump sum;
  • The funds accessed will be tested against her lifetime allowance;
  • Her income payments will still be subject to income tax.

Linda is therefore able to retire from her job as PE teacher and begin to access her pension pot.

Linda has a friend called Joanne who is also aged 53 and works at the same school as a PE teacher. Like Linda, Joanne has also been deemed as being medically incapable of continuing in her occupation due to illness by a registered medical practitioner.

However, Joanne has a different pension provider to Linda.

While the rules of Linda’s pension provider state that she is able to access her pension early as she is unfit to undertake her own occupation, Joanne’s provider is very strict and states that she must be incapable of undertaking any occupation, not just her own, to be able to access her pension early. This means that Joanne must wait for two further years before being able to access her pension pot, when she reaches the age of 55.

Joanne’s neighbour, John, is aged 45 and has just been deemed as having ‘serious ill-health’, meaning that he is expected to live for a year or less.

John is therefore entitled to a particular form of benefit called a serious ill-health lump sum, which can only be taken from uncrystallised or unused funds.

Uncrystallised funds are those pension funds that haven’t yet been accessed and will not have been tested against the lifetime allowance and a pension commencement lump sum won’t yet have been taken. Unused funds are pension funds that haven’t been accessed by the time one reaches age 75. As John is under the age of 75 and he hasn’t taken benefits before, his pension fund is uncrystallised.

John’s serious ill-health lump sum must use up all of the uncrystallised funds within the pension arrangement. As John is under the age of 75, his serious ill-health lump sum is tax free. Due to the fact that his serious ill-health lump sum is greater than the remaining lifetime allowance, the excess will be subject to a 55% lifetime allowance charge that is deducted and paid to HMRC by the scheme administrator before the lump sum is distributed to John.

The important thing to take away from each of these examples is the options available to you in the case of ill-health depend on your scheme and what their rules allow.

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