There are a number of Department for Work and Pensions (DWP) benefits that are means tested, which include the following:
•Income-related Employment and Support Allowance;
• Housing benefit;
• Income support;
•Income-based Jobseeker’s Allowance;
• Universal Credit;
• Pension Credit.
To establish eligibility the claimant’s income and/or capital has to be taken into account. For some benefits there is a joint assessment of the claimant and their partner, so the actions of one partner can affect the other. Where the income and/or capital of a partner has to be taken into account, the initial valuation follows the same process as for the claimant.
Some or all of the claimant’s pension income is also taken into account for contributory benefits, such as contribution-based Employment and Support Allowance and contribution-based Jobseekers Allowance. For these benefits any pension that is not drawn as income is not taken into account.
It is possible to take a lump sum from a pension without these contributory benefits being affected, provided the lump sum is deemed as capital.
Isa
Any Isa, including a Lifetime Isa, will be taken into account in the same way as any other savings account. This is despite the fact that withdrawals from Lifetime Isa, other than after the age of 60, due to terminal ill health or due to an eligible property purchase will incur a 25 per cent government withdrawal charge.
This concern led to the FCA insisting that those taking out a Lisa are warned that doing so could affect any entitlement to means-tested benefits.
Pension
In contrast, monies held within a pension have greater protection, especially before the claimant has reached the qualifying age for state pension credit. This age is linked to women’s state pension age, which will reach 65 by 6 November 2018.
Below state pension credit age
For those who are under pension credit age, a pension will only be taken into account if and when it is drawn. How it is drawn will affect whether it is taken into account as capital or as income, which in turn will affect the impact on the means tested benefit.
Regular withdrawals are likely to be considered income and ad-hoc withdrawals are likely to be considered capital. This could mean that ad-hoc withdrawals from income drawdown are considered to be capital, while taking regular uncrystallised funds pension lumps sums (UFPLS) could be considered to be income.
Other situations may be even less clear, for example an UFPLS taken every other month or drawdown income, which is varied every month.
Notional capital and deliberate deprivation
Care should also be taken if money is being withdrawn from a pension to pass on to others. If the Department for Work and Pensions (DWP) decides that this has been done to secure or increase entitlement to benefits then the entitlement to benefits will be assessed as if the claimant still had that money. See Box one.
Above state pension credit age
The starting assumption for those over the state pension credit age is that any pension should be taken into account.
If no income is being drawn then the amount assessed is the notional income.
If the income is being drawn then the higher of the actual income and the notional income is used. This could apply to a partner’s pension if the partner has reached state pension credit age even if the claimant has not.
Notional income
The notional income taken into account is 100 per cent of the Government Actuary’s Department (GAD) rate. The maximum income that can be drawn from a capped drawdown plan is based on 150 per cent of the GAD rate.
This maximum GAD income is calculated every three years (annually after age 75) and expressed as a cash amount. Therefore, it is not as simple as assuming the notional income is always two thirds of the capped drawdown maximum GAD income. See Box two.
The notional income is required to be revalued after a capital lump sum is taken, after every payment of income drawdown that is higher than the notional income amount, or if the claimant requests that their pension is revalued.
Assuming no market movement, this revaluation should lead to a lower notional income and therefore potentially higher benefits.
Taking no income would, all things remaining equal, lead to the same level of notional income when it is next recalculated. Taking even a fraction of the notional income should lead to a lower notional income, but again this ignores any market movement.
The legislation (for example, regulation 18 of the State Pension Credit Regulations 2002) appears to specify that notional income should be calculated as the maximum income that could be withdrawn.
A strict literal interpretation would have meant that once a claimant reached state pension credit age the whole of their pension pot would be taken into account as notional income. Therefore it appears that since the start of the pension freedoms DWP have taken a more pragmatic approach.
This approach also means the notional income calculated from drawdown, or an undrawn pension, is broadly similar to the actual income available through annuity purchase.
Capital withdrawals
Another potential complication is when ad hoc capital withdrawals are taken. Such a withdrawal would not count as drawing income, so the notional income would still be taken into account. However, it would mean that the notional income would be recalculated based on the remaining fund after the capital withdrawal. See Box 3.
It is unlikely that anyone investing in pensions or Isas will consider themselves likely to need means-tested benefits in the future. But the unexpected can happen and circumstances change. This could apply even if a reasonable amount of cash is kept as an emergency fund.
The ability to access investments earlier than intended should therefore be balanced against the risk that these investments could then reduce any future means-tested benefits.
Philip Warner is head of technical at Hargreaves Lansdown
