Ill-health and serious ill-health

These FAQs are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of proposed legislation, which may change.

It is possible for pension benefits to be taken where a member is in ill-health or serious ill-health. Benefits can be taken on ill-health earlier than age 55 whilst benefits can be taken as a lump sum on serious ill-health at any age. Although there is HMRC guidance covering both scenarios, the rules of a particular scheme will set out what options are actually available in practice. 

Where a member is, and will continue to be, medically incapable of carrying on with their current occupation, because of injury, sickness, disease, or disability, then they may be able to take their pension benefits earlier than the normal minimum pension age of 55.  

A registered medical practitioner must provide the scheme administrator with written evidence of ill-health. HMRC guidance states that the member must actually have stopped working in his or her own occupation. However, scheme rules may have a stricter definition of ill-health and may insist that the client is unable to continue with ‘any’ occupation as opposed to their ‘own’ occupation before they will pay pension benefits early. In practice, for ill-health claims, a declaration that needs to be completed by a registered medical practitioner will normally be included as part of the retirement quote. The completed declaration will then need to be reviewed and accepted by the provider to allow the pension benefits to be paid early on ill-health.

The options on taking pension benefits early should follow what is normally allowed – for example, a tax-free lump sum combined with either drawdown, lifetime annuity or scheme pension (where allowable) or a small pots lump sum or uncrystallised funds pension lump sum (UFPLS) may be offered depending on the type of pension arrangement held and the size of the fund. The lifetime allowance limit is not reduced due to the taking of pension benefits early under ill-health. 

Section 9(2B) rights (held in an occupational pension scheme or a section 32 buyout) can be taken early on grounds of ill-health (with a tax-free lump sum available as normal). However, GMP benefits can only be taken early if the revalued GMP liability at age 65 for men and age 60 for women is met. No tax-free lump sum can be taken from GMP benefits.

Where a member has a reduced life expectancy, they may be able to get a higher income if they purchase an impaired life annuity on a single life basis. Purchase of a joint-life annuity would be costed based on the income being paid until the second person died.

If a member subsequently recovers from ill-health, scheme rules may allow an ill-health scheme pension (but not a lifetime annuity) to be stopped or reduced. For more information on how this is treated please refer to the HMRC guidance here.

Note – a scheme pension is typically paid from a final salary scheme but can also be set-up from a money purchase arrangement although this rarely happens in practice. 

Members suffering from serious ill-health, defined by HMRC as having less than a year to live, can take their uncrystallised pension funds (those that have not been put into payment) as a lump sum at any age. The lump sum paid is referred to as a serious ill-health lump sum.

A serious ill-health lump sum can be paid subject to the following conditions:

  • a registered medical practitioner must provide the scheme administrator with written evidence stating that the member’s life expectancy is less than a year, before the payment is made. In practice, a declaration that needs to be completed by a registered medical practitioner will normally be included as part of the retirement quote. The completed declaration will then need to be reviewed and accepted by the provider to allow the serious ill-health lump sum to be paid.
  • where the member is under age 75, the lump sum is paid tax-free, subject to it being within an individual’s remaining lifetime allowance. See the section below titled ‘Is a serious ill-health lump sum tested against the lifetime allowance?’.
  • where the member is aged 75 or over at the date of payment, the lump sum is subject to a 45% tax charge. The scheme administrator will be liable for this charge whether or not the person who is paid the lump sum is resident, ordinarily resident or domiciled in the UK and they can deduct the charge before the lump sum is paid. Note – the Finance Act 2016 will change the taxation treatment for serious ill-health lump sums paid to someone aged 75 or over from the day after the Act receives Royal Assent. From that date onwards, any lump sum paid will be taxed as pension income (that is, at an individual’s marginal rate of tax).
  • the arrangement the funds are held in must be uncrystallised so no part of it can previously have been crystallised and used to provide pension benefits. Note – this point is due to be relaxed in the Finance Act 2016. From the day after the Act receives Royal Assent, it will be possible for a serious ill-health lump sum to be paid from uncrystallised funds held in an arrangement after that date even if part of the benefits held in the arrangement have previously been crystallised.*
  • the member must have some lifetime allowance left (even if the serious ill-health lump sum is paid after age 75).
  • all uncrystallised funds under the arrangement must be commuted.

* As an example, this could be of benefit where it is possible for part of an uncrystallised arrangement to buy an annuity or be put into drawdown within the same arrangement. That would mean that there would then be uncrystallised and crystallised rights held in the same arrangement. Currently, the uncrystallised rights could not be taken as a serious ill-health lump sum but this will become possible from the day after the Finance Act 2016 receives Royal Assent. 

No. Sufficient funds must be kept back to provide the required survivor’s benefits from any guaranteed minimum pension (GMP) and section 9(2B) rights. As long as the GMP or section 9(2B) rights held back to provide a spouse’s or civil partner’s pension are clearly identified and held in a separate arrangement from those rights being commuted, the condition that all funds under the arrangement must be commuted will be met.

The payment of a serious ill-health lump sum before age 75 is tested against the lifetime allowance as a BCE6. The lump sum is tax-free apart from any amount over the member’s remaining lifetime allowance, which will be subject to the lifetime allowance charge of 55% (assuming the member doesn’t have enhanced protection). The scheme administrator will be liable for this charge whether or not the person who is paid the lump sum is resident, ordinarily resident or domiciled in the UK and they can deduct the charge before the lump sum is paid.

The payment of a serious ill-health lump sum after age 75 is not a BCE as any uncrystallised funds remaining at age 75 will have already been tested against the lifetime allowance at that age. However, for the purposes of checking whether a member has available lifetime allowance, the fact that a BCE 5 or 5B has been done at age 75 is disregarded.

HMRC defines a registered medical practitioner as ‘a fully registered person within the meaning of the Medical Act 1983’. Where a member is not in the UK, the registered medical practitioner can be someone with equivalent overseas qualifications. HMRC always expects that a member in the UK would need to have evidence from a UK registered medical practitioner.

Pensions Technical Services