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

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

Terminal Illness – Pensioner 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 with a pension benefit currently in payment from a defined benefit scheme irrespective of whether your benefits started being paid at Normal Retirement Age or paid earlier through ‘ill-health’ or ‘early retirement’.
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. 
This Factsheet looks at the issues about serious ill-health in relation to pension benefits.
For more information on health issues see our Factsheet My Health.
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.
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.
Although HMRC rules allow schemes to pay a ‘serious ill-health lump sum’ in respect of your pension benefit, it will only apply to you if the rules of your pension scheme permit this option.
What are the HMRC conditions to be eligible for a ‘serious ill-health lump sum’?
HMRC rules list 5 conditions that must be met in order for a person 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’
The ‘serious ill-health lump sum’ is a specific benefit and is not to be confused with any other type of lump sum available from a pension scheme.
What is ‘lifetime allowance’?
HMRC have set a lifetime allowance figure which is the value of 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 (usually only applicable to public sector schemes).
For more information on this see our Factsheets about 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’ would be paid from.
So, if you have begun to draw any of your pension benefit from your employer’s pension scheme you may not be eligible for a ‘serious ill-health lump sum’ from that pension scheme.
If you several separate pension benefits it may be possible for you to receive a ‘serious ill-health lump sum’ if the HMRC eligibility conditions can be met in respect of those specific benefits (see our Factsheet Terminal Illness in the Preserved Category for more information).
If in doubt consult your pension scheme or your financial adviser.
What would be classed as medical evidence?
To qualify for a ‘serious ill-health lump sum’ a 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 the pension Scheme Rules may require that the Trustees seek further independent evidence as proof of serious ill-health - so it will not be sufficient for the member to provide evidence from his or her own GP or consultant.
How is the ‘serious ill-health lump sum’ calculated?
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’ if the rules permit payment.
The scheme actuary will use a formula consistent with other calculations performed for other circumstances such as valuing pension increases, and spouse’s pensions. 
A pension scheme must retain the liability to pay any survivors pension from any ‘contracted-out’ service (see below). If there is contracted-out service, any surviving spouse or civil partner will receive a pension from the scheme in relation to the member’s contracted-out service. If a scheme member receives a ‘serious ill-health lump sum’ it extinguishes the member’s pension benefits in the pension scheme.
If the scheme member is not married or not in a civil partnership at the time the employer’s pension scheme pay the ‘serious ill-health lump sum’, the member can exchange the whole of his or her pension benefit including any contracted-out service.
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 1997, 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 if you were ‘contracted-out’.
Is there any tax to pay on a ‘serious ill-health lump sum’?
There is no income tax payable by the member on the ‘serious ill-health lump sum’.
Neither is the 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 every 5 years 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.
Summary & Key Points
When making enquiries about your pension benefit it is very important that you make it clear that you are a pensioner member rather than an active member or preserved 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.
  • A ‘serious ill-health lump sum’ is only available to scheme members who meet the 5 conditions laid out in HMRC rules.
  • Although HMRC rules allow schemes to pay a ‘serious ill-health lump sum’ payment in respect of a scheme member’s pension benefit, it will only apply to you if the rules of your pension scheme permit this option.
  • 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 v1.2 Pensioner
Last updated 11/01/2007
View our Glossary for definitions of the terms used in our Factsheets

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Terminal Illness - Pensioner Members
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