Ill Health Pensions And Early Retirement

The Rules for Claiming a Pension Early Due to Ill Health

There are two sets of rules you’ll have to satisfy if a disability stops you working and you need early access to your pension. The first set is HMRC’s rules for claiming pensions early due to poor health, which state:

• You must be incapable of doing your job through sufficient physical or mental impairment
• You’ve had to stop working your job due to that disability
• You won’t be capable of returning to your job in the future.

Evidence for this must be provided by a registered medical practitioner, as defined by Medical Act 1983.

The second set of rules are set by your pension provider. These will depend on where your pension is invested, your provider and the scheme administrators / trustees.

For instance, some pension plans let you retire early due to illness if you’re incapable of doing your job. However, other pension plans require you to be incapable of doing any job, even in a lesser role than your current one before you get access to your pension.

While the opinion of your GP is important, your pension provider will likely want evidence from their own independent medical practitioner.

This independent medical practitioner doesn’t actually have to meet you in person – sometimes their judgement can just be based on reading your medical notes. Ultimately it will be your pension provider who decides whether your health is bad enough to justify early retirement.

Remember, your GP signing you off sick is no guarantee that you’ll be able to take your pension early.

You’ll have to satisfy both HMRC’s rules for ill health retirement and meet your scheme’s requirements.

Jonathan Cooper
Senior Paraplanner at Drewberry

Tax Rules On Ill Health Pensions

Broadly speaking, the tax situation you find yourself in if you’re pensioned off early should be the same as if you’d reached your normal retirement age.

This is why there’s involvement from HMRC as well as your pension provider and you have to satisfy both of these parties that you need your pension early because of a disability.

Agreement from HMRC allows your tax position to be the same as someone who accessed their pension and / or retired at their normal retirement age.

Defined Contribution Pensions And Bad Health Retirement

If you have a personal money purchase pension – such as a stakeholder pension or self-invested personal pension (SIPP) – you can typically access your pension pot from the age of 55. (Note that if you’re a member of an occupational money purchase scheme, i.e. one your employer pays into as well as you, the retirement age of the scheme will likely be higher.)

However, if you have to retire before the age of 55 (or your occupational scheme’s normal retirement age) due to ill health your pension provider may let you unlock your pension early.

• Check your pension provider’s rules — every pension scheme has different rules about early retirement due to ill health, usually known as qualifying conditions

• Obtain and submit medical evidence from a registered medical practitioner to support your need to retire early

• Be aware that you will likely have to be assessed by a medical practitioner of your pension provider’s choice as well. It’s their opinion which will ultimately decide whether you qualify for ill health retirement.

Assuming your ill health retirement request is successful, you’ll then have access to your defined contribution pension pot to provide you with a retirement income. You can opt for pension drawdown or buy an annuity.

Although annuity rates have been poor in recent years, it’s likely to be well worth looking into an enhanced annuity if you’ve retired before the age of 55 due to ill health. These will pay a higher pension to those with certain life-limiting health conditions.

John Spink
Head of Financial Planning at Drewberry

How Money Purchase Pensions Are Taxed if You Retire Before 55

If you have a defined contribution or money purchase pension, you’ll still be able to receive an initial lump sum of up to 25% tax-free as if you’d retired on or after your 55th birthday. The remainder can be used to provide yourself with an income, either in the form of income drawdown or an annuity.

Both pension drawdown and an annuity will be taxed as if you’d accessed your pension post-55.

Final Salary Pensions And Ill Health Retirement

Final salary pensions aren’t a pot of money you save into throughout your working life like money purchase schemes. Instead, they’re a promise from your employer to pay you an income for the rest of your life.

The adjustments in the income you’ll receive from your final salary pension if you retire early due to ill health can be complicated to work out and are best left to the scheme’s actuaries and pension experts.

Final salary pensions are calculated based on three factors: the number of years you’e been in the scheme, a definition of your earnings whilst you were a member of the scheme and the scheme’s accrual rate.

While the scheme’s accrual rate won’t change if you retire early, you’ll have fewer years in the scheme and your pensionable earnings at the date of your retirement will be lower, so your final salary pension might be lower too.

Some schemes, however, may provide additional service credits to cover some or all of the service that you would have accrued had you not been forced to stop working through ill health. Other schemes may provide enhancements such as bridging pensions to compensate for the fact that you won’t get the state pension until state pension age.

How Are Final Salary Pensions Taxed When You’re Pensioned Off Early?

Final salary schemes represent a promise from your company to pay you an income for life. This income will be taxed in the normal way if you retire early due to poor health, just as if you’d reached the scheme’s normal retirement age. You may get an enhanced pension from your final salary scheme if you’re in ill health to accommodate the fact that you’ll likely be drawing on it for fewer years.

Terminal Ill Health And Final Salary Pensions

If you have a defined benefit pension, the rules surrounding whether you can be pensioned off early due to serious ill health vary considerably between schemes. The rules of your final salary scheme take precedence here, so the only way of knowing for sure what you’ll be offered on being diagnosed as terminally ill is to check with your provider.

Some will offer you an ‘accelerated payment’, paying you the first 5 years of final salary income you’d ordinarily have received as an upfront lump sum. Others may have no ability for you to take any additional benefits from the scheme to take into account your severely compromised life expectancy.

Again, a final salary pension transfer could be a better option here for getting access to your retirement cash if you’ve been diagnosed as terminally ill but this will only be the case for a minority of people.

Once a final salary transfer has taken place and the cash equivalent value has been moved into a defined contribution pension, you can take the 100% tax-free sum from it once you provide medical proof that you’re terminally ill. Alternatively, you could move it to drawdown or another arrangement that will offer optimum tax efficiency for you and your loved ones in the future.

I’m in Poor Health: Should I Transfer Out of My Final Salary Scheme?

If you have a final salary pension and you’re thinking of requesting to be pensioned off due to poor health, it may be worth considering a final salary pension transfer. This involves taking a cash lump sum invested in a defined contribution pension in exchange for giving up the right to an income for life.

You can request a cash equivalent transfer value from your final salary scheme, which may take into account your ill health when providing you with a transfer value.

Having this pot of cash to pass down to your loved ones has a number of benefits compared with having your pension in a defined benefit scheme, where there’s no cash to inherit.

There’s no inheritance tax to pay when you leave a pension pot to your beneficiaries (providing it remains invested in a pension or in drawdown). Your beneficiaries also won’t have to pay income tax if you pass away before the age of 75.

However, generally speaking, while ill health is one factor to take into consideration when weighing up the advantages and disadvantages of a final salary transfer, it’s not the only factor. This is a complicated decision and will only be suited to a minority of people based on their individual needs and circumstances.

Don’t forget, final salary pensions often offer a widow’s or survivor’s pension for your spouse, and may even provide an income for dependent children after your death. You’ll be losing these if you leave your defined benefit scheme, so it’s important to weigh all the options and seek expert pensions advice.

Can I Claim The State Pension Early?

No, you can’t get the state pension any earlier than your State Pension age regardless of the state of your health. This is why it’s so important to have an alternative arrangement to the State Pension, one that you will be able to access early should your health stop you working.

Other state benefits are available, such as Employment and Support Allowance and other disability payments to tide you over, but the State Pension is not available if you retire early due to ill health.

Will I Still Get The Full State Pension If I Have Retired Early?

It’s possible you won’t be entitled to the full State Pension if you retire early due to ill health. Men born on or after April 6, 1951 and women born on or after April 6, 1953 will receive the New State Pension, eligibility for which is based on your National Insurance (NI) record.

To qualify for the full new state pension, you’ll need 35 years of National Insurance contributions. If you’ve retired due to ill health before paying in those 35 years you could face a lower state pension than you thought.

This government calculator lets you check how much of the new state pension you’re entitled to.

I Don’t Think I’ve Paid Enough NI Contributions for the Full State Pension

You may be eligible to receive National Insurance Credits because of your illness or disability between the age you retire due to ill health and your state pension age. You may also be able to ‘top up’ your National Insurance contributions with voluntary contributions if necessary. More on this can be found here.

What If My Health Improves After Retiring Early?

Should your condition improve after you’ve been pensioned off early due to bad health, HMRC’s tax rules allow for your pension to be reduced or even stopped at any time.

This is at the discretion of your pension provider. Some have rules surrounding improvements to your health if you’ve retired early due to disability, while others will not reassess you to ensure you’re still entitled to your ill health pension.

However, if provisions for reassessing your pension are included in the scheme’s rules, then your provider is entitled to adjust your ill health pension to a level it deems appropriate to your ability to work. For instance, if your health improves so that you can return to work part-time, your pension may be reduced to reflect your part-time earnings.

Should your health deteriorate again, it’s possible for your pension provider to recommence or increase your pension to the level it was at before it was stopped / reduced.

Advice On Pensions And Poor Health

As you can see from the above guide, being pensioned off early due to ill health or disability can be quite complicated. There are a number of factors to consider, particularly if you’re a member of a final salary scheme.

The taxation of poor health pensions is another issue that can be fraught with difficulties and that is why it is so important you can make an informed decision – not just yourself but also any beneficiaries.

If you’re ill, having a conversation with an adviser is probably the last thing on your mind. However, it’s so important to get financial advice if you’re leaving work early due to bad health – otherwise you risk potentially not doing the best thing for you and your family. A conversation with an adviser can bring huge peace of mind so you can focus on your health.

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