Caitlin Southall, pension technical manager at Curtis Banks, considers what constitutes ill-health and serious ill-health and how these definitions affect an individual’s ability to draw from their pension(s) pre-age 55.
The sad reality is that some advisers will support clients who are in ill-health at some point during their advice relationship. The FCA’s Financial Lives Survey published last year estimated that 9% of adults in the UK were in poor health. The report defines poor health as having a condition or illness that has a substantial and long-term adverse effect on their ability to carry out normal day-to-day activities.
The current minimum age to access private pensions is 55, although this is due to increase to 57 in April 2028. There are currently few mechanisms through which people can access their pension earlier than this. One reason to do so for people in certain professions like athletes, who tend to have shorter careers, expediting a potential need to access their pension. Another driver for accessing pensions earlier is ill-health.
What constitutes ill-health?
When it comes to defined contribution pension rules, there are specific criteria as to what constitutes ill health. A person is considered to be suffering from ill-health if they are, and will continue to be medically incapable of continuing their occupation, and have stopped working because of their poor health. This is the legislative position but it’s aways worth checking scheme rules in case any additional requirements have been put in place.
For those clients that meet the ill-health criteria, they have the ability to access their pension before the normal minimum pension age (NMPA). However, the options available to them in terms of taking their pension benefits and the taxation that applies as a result are the same as if they were accessing their pension after NMPA. They still have the option of taking their pension commencement lump sum (PCLS) entitlement. Assuming that the abolition of the lifetime allowance (LTA) goes ahead as planned in April this year, any PCLS that they take would contribute towards their Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LSDBA), and any income that they take from the pension would be subject to income tax.
Serious ill-health
There is a distinction between ill-health and ‘serious ill-health’. Clients in serious ill-health are entitled to a serious ill-health lump sum. This is generally where schemes receive evidence the individual is expected to live for less than one year. This type of lump sum can only be taken from uncrystallised funds. In the event that a client holds both crystallised and uncrystallised funds, any serious ill-heath lump sum could only be taken from the latter element. It’s important to note that the entirety of the uncrystallised funds in the pension must be paid as the serious ill-health lump sums – no unused funds can remain in the pension after the lump sum is paid.
As part of the transitional arrangements for the LTA abolishment, serious ill-health lump sums are to be tested against the LSDBA. With a PCLS or tax free elements of an UFPLS, a client’s LSDBA will be reduced by 25% of the LTA already used up under the new rules. However, there is a nuance here for serious ill-health lump sums that were paid prior to 6 April 2024 (the abolition date for the LTA). In these cases, the LSDBA is reduced by 100% of the previously utilised LTA.
Serious ill-health lump sums are tax free is they are paid under the age of 75 and paid within the remaining LSDBA noting the above reduction. If there was any excess paid over and above the available LSDBA, then the excess would be taxed at the client’s marginal income tax rate. Likewise if the lump sum was paid on after the client’s 75th birthday, this would make the payment taxable.
Provider requirements
Providers will have varying requirements when it comes to accessing pensions earlier than the NMPA on medical grounds. But in all reality, with both ill health and serious ill-health, providers are likely to need confirmation of the clients’ health status from a registered medical professional before paying making any payments from the pension.
For advisers and providers, it’s important to consider that for those people considering accessing their pension due to ill-health or serious ill-health there is a likelihood of vulnerability under Consumer Duty. One of the four key drivers of vulnerability under Consumer Duty regulations is health. Whilst vulnerability does impact the requirements or outcomes available, it does mean that adjustments may be required to the way that information and options are delivered to ensure maximum understanding for the client.
When it comes to ill-health and pensions, it’s critical that clients seek financial advice where possible. There may be other investments, assets or wealth that could be called upon before looking to access the pension fund, and people may want to consider benefits which would be paid to their family after their death alongside what they may be able to get during their remaining lifetime.
