The imminent change to the rules around when a client can access their pension pot comes at the same time as people are living longer.
From April 2028, individuals will have to wait until they reach the age of 57 to access their tax-free lump sum – the current age is 55.
One of the challenges this could pose, according to Claire Trott, divisional director for retirement at St James Place, is that “the longer a person has to wait to access the pot, the greater the potential for them to become ill and unable to work”.
There is a provision within the law enabling an individual who is no longer able to work to access their pension pot, with guidance provided by HMRC around the conditions that have to be met – this is called an ill-health early retirement.
But while the guidance is explicit, Trott and a range of other industry experts agree that those guidelines are merely minimum requirements, with scheme rules varying and creating potential pitfalls for advisers and their clients seeking to access an ill-health early retirement pension.
FT Adviser recently highlighted a case where an individual who had spent several years as a full-time mother was initially not eligible to access their pension pot early, as the HMRC rules indicate the pension pot can only be accessed early on the basis of replacing income from work, so a client with no income from work is not eligible.
Clare Moffat, pensions expert at Royal London, says if a client does access their pension pot on health grounds and is then not eligible, “this counts as an unauthorised withdrawal and so would incur a tax liability”.
HMRC rules
HMRC’s guidance is explicit, stating that for a pension to be entitled to an ill-health early retirement pension, “they must be either physically or mentally unable to carry out their normal occupation”, but Moffat says the change is that individual schemes may have further rules, such as whether a person could do another job in future.
A registered medical professional must sign the paperwork stating the individual cannot work, and this evidence must be kept by the pension provider for six years after the claim is made.
Trott says one of the issues with the current guidance is that it dates back to 2004, and references a 1978 piece of legislation. She notes this was "a period of time when defined benefit pension schemes were commonplace, and when most people had only one job or career, so it was clear cut if they could not work in that career any longer, but in a defined contribution world, it's different”.
Moffat says a person could have a high-earning but highly stressful job and be found to no longer be able to work at that, but have a substantial pension pot, and then be asked to take another, lower waged but less stressful role.
She says this tends to depend on the rules of the individual scheme, but that generally with DC schemes, the view is that if a person cannot do their current role, then it is sufficient to qualify them for ill-health early retirement.
Rachel Vahey, head of public policy at AJ Bell, says: "It becomes more complicated if a member is unable to perform their occupation but could perform a different type of occupation, for example a desk-based job following an accident. Then it may depend upon the scheme rules.
Some people may want to know what happens if they recover and go back to work. This isn’t something that is covered in depth by HMRC guidance.Rachel Vahey, AJ Bell"Some may say early access is allowed if you cannot continue ‘your occupation’ and others may state it’s only allowed if you cannot continue ‘any occupation’.
"Someone who is working in a business as a senior manager or director may get caught by this. For example, they may not be able to perform their previous high-powered job and decide to return on a consultancy or reduced basis, purely because they are reluctant to sever all ties. But if they are still involved with the company at the same level, HMRC may view that as performing the same role. In this case they may find it easier to walk away."
She adds that a client must already have stopped doing their occupation in order to seek an ill-health early retirement.
In the case highlighted by FT Adviser above, the client in question had to provide evidence that the ill-health meant they could not do their most recent paid job, as a receptionist, despite that having been many years ago.
Trott says the most important consideration for any adviser looking at the issue of ill-health early retirement is the scheme rules, more than the HMRC guidance, as the latter is a minimum requirement and schemes are not obliged to offer the full range of options beyond that.
An example of varying options is that within NHS pension schemes there is a tier one and a tier two option, depending on the level of stress associated with the role.
Vahey highlights another area where HMRC is not very specific in its guidance, saying: “Some people may want to know what happens if they recover and go back to work. This isn’t something that is covered in depth by HMRC guidance – that only mentions reducing a DB scheme pension.
"Returning to work shouldn’t strictly invalidate the earlier benefits but it’s something HMRC could probe into, especially whether the person genuinely met the ill-health criteria in the first place. And it’s worth checking scheme rules on this point – some may require any income payments to stop on recovery, others allow them to continue.”
Moffat says that this again varies under different scheme rules, but that as a general rule “retirement can be stopped”, and a person can return to work.
Safety net
That notion feeds into another issue cited by Trott, which is that some pension schemes still operate on the assumption that a client will buy an annuity, rather than enter drawdown, and this may be difficult for a person who is retiring at an early age due to the number of years an income needs to last.
In the case of someone entering drawdown, the issue may arise that the income is more volatile, and this may not suit all clients, so Trott says understanding an individual scheme's rules around this is also key for an adviser when looking at this issue on behalf of a client.
David Thorpe is investment editor of FT Adviser
