What to consider when accessing pensions early due to ill-health

Once the medical evidence has been accepted and the member has ceased the relevant occupation, benefits can be taken. The options available under the scheme will be the same as if they have been accessed at normal retirement age.

Benefits taken early under ill-health will be taxed in the usual way – that is, 25 per cent of funds crystallised can be taken as tax-free pension commencement lump sum (PCLS) up to the lifetime allowance with the balance used to provide a taxable income, or 25 per cent tax-free/75 per cent taxable uncrystallised funds pension lump sum(s) (UFPLS) can be taken.

It is also worth noting that, unlike with some protected pension ages, there is no reduction in the lifetime allowance available due to taking benefits earlier.

 One area where you do need to be careful is transfers.

It is also possible for benefits taken early under ill-health to stop if the member recovers and returns to work. This would be unusual as to meet the criteria at outset they have to have been deemed medically incapable of working on a continuing basis. However the rules do allow for recovery and recognise that the prognosis can change.

Under these circumstances the recovery does not make the benefits already taken unauthorised, so no penalty will apply provided the condition was met at the time benefits were first paid out. Neither does recovery itself mean benefits must cease – although some scheme rules may – as the test is a one-off at the time benefits are crystallised. 

It is worth noting though that taking any income under flexi-access drawdown or taking an UFPLS will trigger the money purchase annual allowance so the ability to rebuild funds on returning to work will be reduced. 

Transfers

One area where you do need to be careful with those in receipt of ill-health pensions is on transfer. 

Take the example of a client who is unable to continue in their current full-time, high-stress occupation at the advice of their doctor. However after a break to recuperate, they want to do something completely different and move to a more relaxed, part-time job in a different field.

In these circumstances they may want to access some of their pension (especially if they have substantial savings) to top up their significantly reduced income.

Provided their pension scheme rules allow the maximum flexibility, meaning they can access benefits when they stop their original occupation, then they can take early ill-health pension. If they later start work in their new occupation then that pension can continue. 

If you decide with the client that it is appropriate to transfer the pension to a new provider, for whatever reason, then you need to be careful with the timing.