MyCompanyPension.co.uk - Helping members of occupational pension schemes to better understand their benefits.

25th August 2019
:: Scheme Member | Drawing My Benefits | Terminal Illness | Active members of a DB scheme

Terminal Illness – Active Members
This Factsheet discusses some of the main issues relating to serious ill-health - more commonly called terminal illness - in relation to your retirement benefits. 
 
It is written for people who are active members of a defined benefit scheme. 
 
Introduction
 
This Factsheet looks at the issues about serious ill-health in relation to pension benefits.
 
If you are diagnosed as being terminally ill you have probably given up work – but you may still be classed as an active member of your pension scheme. It depends upon what you agreed with your employer and how your service is treated.
 
If you are an active member any benefits available to you may differ from those available to preserved members (those people that have ceased to be an active member of your scheme) or pensioner members.
 
Some of the points are more obvious than others, but they are all important.
 
If you are intending to get advice from a Financial Adviser these are the types of issues you should expect to be asked to consider (and often many more).
 
For more information on health issues see our Factsheet My Health.
 Top 
 
What is serious ill-health?
 
In pension legislation, the phrase terminal illness is not used.
 
Instead, the term ‘serious ill-health’ is used which is described as someone having a life expectancy of less than one year.
 
So, whilst you may be medically diagnosed as ‘terminally ill’ and perhaps have been told you have at most several years to live, the rules governing pension benefits are more rigid.
 
Pension schemes can only consider ‘serious ill-health’ for someone having less than one year to live.
  Top 
 
Why is serious ill-health important in terms of my pension benefit?
 
If you suffer serious ill-health and have a life expectancy of less than one year, you may be able to get the whole of your pension benefit exchanged and paid to you as a lump sum. This is called a ‘serious ill-health lump sum’ and is not to be confused with any other type of lump sum available from a pension scheme.
 
Her Majesty’s Revenue and Customs (HMRC) rules allow pension schemes to exchange a member’s pension benefit for a ‘serious ill-health lump sum’ subject to certain conditions being met.
 
Example:
 
Jane Smith is age 57 and unmarried. She has been diagnosed as suffering serious ill-health with less than a year to live.
 
She is an active member of her employer’s pension scheme and has a pension estimated to be worth £6,700 p.a. at age 60, her Normal Retirement Date. Her scheme rules permit her to exchange her pension because of ‘serious ill-health’.
 
The scheme calculates that in exchange for her pension she can have a ‘serious ill-health lump sum’ equal to £103,500.
 
This extinguishes all of her pension rights within the pension scheme.
 
This could have important financial consequences for you and your dependants.
 
Although HMRC rules allow schemes to pay a ‘serious ill-health lump sum’ payment in respect of your pension benefit, it will only apply to you if the rules of your pension scheme permit this option.
 
If they don’t, then you or your representative could write to the Trustees to see if they will amend the Scheme Rules to include this.
 
Remember that your pension benefits may form only part of your financial arrangements and should be included in any inheritance tax solution you have undertaken. There may in certain circumstances be tax to pay on any lump sum taken and therefore it is very important that you seek advice.
  Top 
 
What conditions must I meet in order to be eligible for a ‘serious ill-health lump sum’?
 
HMRC rules list 5 conditions that must be met in order for you to be eligible to receive a ‘serious ill-health lump sum’. These are: 
  • your scheme administrator must have received written medical evidence from a registered medical practitioner, usually of their choice
  • payment of a ‘serious ill-health lump sum’ must be paid before your 75th birthday
  • the ‘serious ill-health lump sum’ payment must extinguish all of your pension rights under the scheme
  • you must not have used all of your ‘lifetime allowance’
  • the ‘serious ill-health lump sum’ must come from an ‘uncrystallised arrangement’
What is ‘lifetime allowance’?
 
HMRC have set a lifetime allowance figure which is the maximum amount of pension benefits an individual can draw over their lifetime without attracting penal tax rates. For the tax year 2006/2007 the figure has been set at £1.5 million. This figure will increase gradually to £1.8 million by 2010/2011, and will be reviewed after that.
 
The lifetime allowance includes all of your pension arrangements, whether money purchase or defined benefit. This also includes any AVCs, FSAVCs, and separate lump sum arrangements. For more information on this see our Factsheets on A-Day.
 
What is an ‘uncrystallised arrangement’?
 
An ‘uncrystallised arrangement’ means that you must not have previously drawn any benefits from the particular pension arrangement that the ‘serious ill-health lump sum’ is being paid from.
 
Are there other requirements I should know about?
 
Your scheme administrators (not you) must report to HMRC when a ‘serious ill-health lump sum’ has been made in two specific sets of circumstances. Broadly speaking this includes if you as a recipient of the ‘serious ill-health lump sum’ are or were a director (or you are or had been connected with a director) of the employer sponsoring the pension scheme. The other circumstance is where you are relying upon ‘enhanced protection’ in respect of the ‘lifetime allowance’. (Enhanced Protection falls outside the scope of this Factsheet. For more information on this see our Factsheets on A-Day.
  Top 
 
Do I have to undergo tests to prove I qualify for serious ill-health?
 
To qualify for a ‘serious ill-health lump sum’ your pension scheme must have obtained written medical evidence from a registered medical practitioner (as defined by the Medical Act 1983).
 
It is important to note that your pension Scheme Rules may require that the Trustees seek further independent evidence as proof of serious ill-health - so it will not be sufficient that you provide evidence from your own registered GP or specialist.
  Top 
 
How is the ‘serious ill-health lump sum’ calculated?
 
Your pension scheme will instruct the scheme actuary to calculate the value of your pension entitlement. There is no prescribed formulae set out in legislation and each pension scheme will have its own basis of calculating the
‘serious ill-health lump sum’.
 
The scheme actuary will use a formula consistent with other calculations performed for other circumstances such as valuing pension increases, and spouse’s pensions. 
 
If you are married or have a civil partner, your scheme must retain the liability to pay any survivors pension from any ‘contracted-out’ service (see below). If you have contracted-out service, then upon your death your surviving spouse or civil partner will receive a pension from the scheme in relation to your contracted-out service. If you receive a ‘serious ill-health lump sum’ it replaces your pension benefits in your employer’s pension scheme.
 
If you are not married or not in a civil partnership at the time your employer’s pension scheme pay you the ‘serious ill-health lump sum’, you can exchange the whole of your pension benefit including any contracted-out service.
 Top 
What is contracted-out service?
 
Since 1978, as well as the Basic State Pension (often called the ‘Old Age’ Pension) you may have been eligible to build up additional state pension benefits which would be paid at State Pension Age.
 
Between 6th April 1978 and 5th April 2002, this additional state pension was known as SERPS - the State Earning Related Pension Scheme. SERPS was replaced by the State Second Pension (S2P) which came into effect on 6th April 2002.
 
If your pension scheme was ‘contracted-out’ you exchanged your additional state pension (but not your Basic State Pension) in return for your scheme promising to pay you a minimum pension instead. Both you and your employer paid reduced National Insurance contributions for the period you were ‘contracted-out’ of the state scheme.
 
Your Basic State Pension is unaffected by you having been ‘contracted-out’.
  Top 
 
Is there any tax to pay if I get a ‘serious ill-health lump sum’?
 
There is no income tax payable by you on the ‘serious ill-health lump sum’.
 
Neither is your pension scheme or employer liable to tax.
 
However, if the amount of ‘serious ill-health lump sum’ exceeds the available ‘lifetime allowance’ then tax is payable at 55% on the excess. Yes, that’s right - 55% tax on the excess!
 
Remember that HMRC have set the lifetime allowance for the tax year 2006/2007 at £1.5 million and that this figure will increase gradually to £1.8 million by 2010/2011, and will be reviewed after that.
 
The vast majority of scheme members won’t suffer the 55% tax because the value of their benefits is nowhere near the ‘lifetime allowance’ figure.
 
Your adviser will be able to assist you in obtaining the necessary figures to check whether this would apply to you.
  Top 
 
What other options do I have if I suffer serious ill-health?
 
It is sensible to consider all other options available to you if you suffer serous ill-health. Each option should be considered on its own merits, and then compared with one another before you choose the best one for you and your dependants.
 
Other options:
 
Ill-health. Does you pension scheme pay benefits on the grounds of ill-health (not serious ill health), and would you qualify? What would you get if you were given your pension benefit on the grounds of ill-health (as an alternative to serious ill-health)?
 
Early Payment. What would you get if you were granted ‘early payment’ – commonly called ‘early retirement’ (i.e. not on the grounds of ill-health)?
 
Do nothing. What would be payable to your dependants (or your estate) on your death if you took no action i.e. left your benefits in the scheme as they are?
 
Transfer your pension benefits. Would you be better opting-out of your employer’s pension scheme and transferring your pension benefit to another arrangement?
 
When writing to your pension scheme you should make it clear that you require information on each of the above options, not just one option, so that they may be used for comparison purposes.
 
You should make clear why you are requesting this information as time will play an important factor in your decision-making.
 
You need to carefully consider whether exchanging your pension for a lump sum would affect any benefits payable to your spouse, partner, dependants or your estate.
 
Each option is briefly explained below.
  Top 
 
Could I apply for my pension benefit on the grounds of ill-health instead?
 
HMRC rules allow registered pension schemes to pay benefits before pension age or Normal Retirement Date if you suffer from ill-health. This is different to serious ill-health. If you have been diagnosed as suffering serious ill-health you should write to your pension scheme and request details of what benefits would be available if paid out under ‘normal’ ill-health terms. This can be compared against the benefits that may be available from the other alternatives.
 
What qualifies as ill-health?
 
The HMRC rules state that to qualify for ill-health (rather than serious ill health): 
  • your scheme must have received medical evidence from a registered medical practitioner,
  • the scheme must be satisfied that you are and will continue to be incapable of carrying out your job either through physical or mental illness.
Ill-health benefits may include: 
  • a lump sum,
  • a pension,
  • death benefits for your spouse, partner, dependants or your estate
It is up to each pension scheme whether they offer ill-health benefits to their members. If your pension scheme does allow ill-health pension benefits to be paid, you may need the consent of the sponsoring employer as well – it will depend upon the Scheme Rules. Proof of your ill-health will be required and each scheme will have its own procedures to follow before granting you ill-health benefits.
 Top 
What age can ill-health benefits be paid from?
 
Your Scheme Rules will define your pension age or Normal Retirement Date. For most people this will be between ages 60-75. However, the payment of any ill-health benefits may be granted before age 50.
 
It is important to compare the benefits available under ill-health to those that may be payable through early retirement. Some schemes apply a penalty to benefits if you take them through early retirement. Many schemes do not apply a penalty to benefits paid through ill-health, therefore making ill-health terms more attractive.
 
If the Rules of your pension scheme don’t currently allow ill-health benefits to be paid to active members, a written request to the Trustees may result in the Rules being amended.
  Top 
 
Could I apply for early payment as an alternative?
 
If you are diagnosed as suffering serious ill-health other options may be available to you and ‘early payment’ is one possibility.
 
Your Scheme Rules will define your pension age or Normal Retirement Date and for most people this will be between ages 60-75. However, HMRC rules allow pension schemes to start to pay benefits at any time between 50-75. The minimum pension age rises to 55 from April 2010. Our Factsheet My Retirement Date provides further details.
 
Your pension scheme may allow you to take your pension benefits earlier than your pension age or Normal Retirement Date. This is most commonly called ‘early retirement’ or ‘early payment’ although there is no legal requirement for a pension scheme to have to include it as an option available to its members.
 
So, whether you can draw your benefits earlier than your Normal Retirement Date will depend upon the Scheme Rules.
 
Except on the grounds of ill-health or serious ill-health, ‘early payment’ before age 50 is not possible (age 55 from April 2010).
 
Early Payment benefits may include: 
  • a lump sum,
  • a pension,
  • death benefits for your spouse, partner dependants or your estate.
Note that whilst payment of benefits through ‘early retirement’ may be possible, your pension benefits may be reduced. Penalties are often applied to benefits taken before they are due.
 
For further details on this see our Factsheet My Retirement Date.
  Top 
 
What would be payable to my dependants on my death?
 
If you are diagnosed as suffering serious ill-health then as part of the review of your pension benefits you should obtain information on what benefits will be paid on your death and to whom.
 
This should be done whether you are able to access your pension benefits 
  • on the grounds of serious ill-health,
  • on the grounds of ill-health,
  • on the grounds of ‘early retirement’ (sometimes called ‘early payment’).
You should also see what benefits are available if you do nothing and leave your pension benefits within your pension scheme.
 
If you are close to your Normal Retirement Date you will need to request: 
  • what benefits are available if you die before your Normal Retirement Age (i.e. details of any lump sum and/or spouse’s, civil partner’s or dependants’ pensions),
  • and separate details if you die after your Normal Retirement Date.
Most pension schemes provide some form of death benefit, although there are those that pay nothing at all – so it’s always better to check.
 
Benefits payable on your death may include: 
  • a lump sum,
  • a pension,
  • death benefits for your spouse, partner dependants or your estate.
Remember to emphasise that you are an active member of the pension scheme (if you have retained that status), as death benefits often differ for active, preserved and pensioner members.
  Top 
 
Who would receive benefits on my death?
 
Benefits may be available for your spouse, civil partner, children or other dependants or nominated beneficiaries. But be careful to establish precisely to whom benefits would be payable as there are many different restrictions that can apply such as: 
  • Is your spouse’s or civil partner’s pension ‘age-related’ i.e. would it be reduced if your spouse or partner was for example, 10 or more years younger than you. (Some schemes reduce the amount of death benefits where a surviving spouse or civil partner is much younger than you - typically 10 or more years younger).
  • Is there a rule affecting the length of your relationship (i.e. is your spouse’s or civil partner’s benefit reduced or withdrawn if you die within say, six months of the date of your union)?
Many occupational pension schemes provide benefits to financially dependent persons whether legally united or otherwise. There may also be similar considerations for same-sex partners.
 
Trustees usually have the ability to use discretionary powers where scheme rules do not specifically cover a set of circumstances, for example where you have not nominated a specific beneficiary.
 
When writing to your pension scheme you should advise any change to your marital status as mentioned above.
 
See our Factsheet My Marital Status.
  Top 
 
Could I transfer my pension benefits?
 
As an alternative to taking benefits under your scheme’s arrangements for serious ill-health, ill-health, early payment and establishing the death benefits available from your pension scheme, you could consider opting-out of (leaving) your employer’s pension scheme and transfer your pension benefits away from your pension scheme to an alternative arrangement.
 
Warning:
 
Considerable care should be taken with this option. Many pension schemes provide active members with some form of life assurance normally referred to as a Death In Service lump sum. If you consider opting-out of your pension scheme you must check to see whether you would cease to be eligible for any Death In Service benefit.
 
Normally a transfer value is only calculated for preserved members.
 
This would involve you making the decision to cease being an active member and become a preserved member, which is a serious step and not one to be taken lightly. The benefits provided for active members could vary significantly to those for preserved members, and this may affect the other options you are investigating.
 
Therefore, although not normally available, if you explain your circumstances, you could ask if your scheme would be willing to provide a ‘notional’ transfer value. That is, you would still be an active member, but they agree to calculate a transfer value as if you were a preserved member.
 
There is a danger here, because this notional transfer value would probably not be guaranteed, and may change. If you decide to transfer based on this figure, and so become a preserved member, once the actual transfer value is calculated, the market conditions may have affected the calculation, perhaps reducing the amount you thought you would have.
 Top 
Before opting-out you would need to obtain from your pension scheme a comprehensive list of benefits that you would get if you stayed in the scheme, as well as the ‘notional’ transfer value of those benefits. This is the amount your scheme would pay to another pension arrangement if you decided to transfer your pension benefits. If you have pension benefits earned in the pension scheme before April 1988, your scheme does not have to release that portion of your pension benefits – although many schemes will.
 
This is a specialised area and requires considerable expertise. It should ideally be performed on your behalf by a specialist adviser appointed by you. Your adviser would compare the benefits you have within your pension scheme against those that would be available if you transferred to a private arrangement such as a Personal Pension Plan, Stakeholder Plan, Self-Invested Personal Pension Plan (SIPP) or any combination of these. There are a number of alternatives – each with its own advantages and disadvantages.
 
In certain circumstances opting-out and transferring your pension benefit may provide you, your dependants, or your estate with better benefits whether this is achieved through: 
  • taking your benefits immediately once the transfer was completed or
  • improving the benefit payable on your death.
What about policy fees and charges?
 Top 
The effect of any policy charges, fees or commissions would need to be considered by you as part of the exercise.
 
You should also ensure that if you are intending to take immediate benefits from your new pension policy that you are aware of the policy terms and conditions. This would include finding out whether there are penalties for taking benefits early or whether there is any minimum time period before benefits can be drawn.
 
Example:
 
Your new pension policy may state that you are not allowed to take any benefits for the first 3 months. This could affect your decision on whether to transfer in view of your health.
 
You should note that there are occasions when a transfer value could be reduced i.e. the transfer value does not represent 100% of your pension benefit.
 
Comment:
 
A transfer analysis requires detailed information and is time-consuming. It can often take several months for a pension scheme to provide a transfer value - if indeed the scheme was prepared to offer one which is ‘notional’ (i.e. not guaranteed). Explaining your circumstances may speed up the process.
  Top 
 
Summary & Key Points
 
When making enquiries about your pension benefit it is very important that you make it clear that you are an active member rather than a preserved member or pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
 
On average, people change jobs every 5 to 6 years. It is possible therefore, that you will have more than one pension benefit. For each pension benefit you need to consider the following items: 
  • Would you be able to exchange your pension benefit on the grounds of serious ill-health?
    • Would this require consent from the sponsoring employer, the Trustees or both?
    • What would this provide in terms of a lump sum?
    • What if any, pension benefit would remain from any contracted-out service?
    • Is any tax payable?
  • Would you be eligible to apply for immediate benefits due to ill-health?
    • Would this require consent from the sponsoring employer, the Trustees or both?
    • Would this provide
      • a lump sum,
      • a pension, or
      • other death benefits for your spouse or partner and dependants?
  • Can you get your benefits under ‘early retirement’?
    • Would this require consent from the sponsoring employer, the Trustees or both?
    • What would this provide (see bullets above for ill-health)?
    • What penalties are there?
  • If you do nothing, and remain as an active member (if this is what you agree with your employer), what benefits would be available if you die before your Normal Retirement Date, to your spouse, partner, dependants, nominated beneficiaries, estate? (See bullets above for ill-health). Are there any specific criteria that apply, such as:
    • benefits payable to a legal spouse or civil partner only,
    • benefits payable only to the spouse or civil partner you were married/registered to at the date you ‘left’ the scheme (if indeed you did),
    • children’s pensions payable up to a specific age, or 
    • proof of dependency
  • Get professional advice and ask for a thorough pension analysis. Compare the possibility of opting-out of your pension scheme and transferring your pension benefit where you:
    • draw benefits immediately,
    • partially draw benefits, or
    • leave benefits - if these improve the death benefits available to your spouse, partner, dependants, estate.
  • Compare all of the above.
  • Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
  • Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
  • HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
 
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
 
 
Terminal Illness v1.6 Active
Last updated 11/01/2007
 
 Top 
 
 
Glossary
View our Glossary for definitions of the terms used in our Factsheets
 

PDF version
Open, download
or print a
PDF version
of
this document
 

How to read PDFs
Adobe Reader enables
you to view and print
PDF files
 
 
 


Document PDF Download
Terminal Illness - Active Members
© MyCompanyPension.co.uk Ltd – 2019