Pension Transfers and Serious Ill Health Lump Sums

We often see pension transfer cases where the client is in ill health and with this as the primary driver for transferring away from a defined benefits scheme, i.e. to make available a lump sum benefit in the event of death rather than the scheme dependants’ pensions. While this can be a strong driver for transferring, consideration should be given to whether the client would be able to qualify for a serious ill health lump sum within their existing scheme and, if so, what the terms of this would be.

What is a serious ill health lump sum?

A serious ill health lump sum is exactly what it says – a lump sum payment to the member of a scheme who is in serious  ill health and who meets certain defined conditions.

Qualifying for a serious ill health lump sum

There are specific criteria that must be met in order to qualify for a serious ill health lump sum , which include the following:

  • The client must be in serious ill health
    … this is defined by HMRC as having life expectancy of less than 12 months
  • The administrator of the scheme must receive evidence of ill health from a medical practitioner
    … a medical practitioner essentially means a person who is fully registered within the meaning of the Medical Act 1983
  • The scheme must offer the option of a serious ill health lump sum
    … it is not a requirement that all schemes offer a serious ill health lump sum and some don’t while some schemes offer this option but only for members with specific benefits
  • The member must have some lifetime allowance remaining
    … the payment of a serious ill health lump sum is a benefit crystallisation event (BCE) and therefore tested against the Lifetime Allowance (LTA) – see below. As such, the client is required to have some LTA remaining. This requirement applies even where the client is aged over 75 although it does not need to cover the full amount of the lump sum payable
  • Payment must crystallise all of the benefits under a certain arrangement
    … it is not possible to partially crystallise benefits under an arrangement, and therefore full crystallisation must take place. If an arrangement has been partially crystallised, then in order to qualify, the remaining uncrystallised element must be crystallised

Where any of the above elements are not met, a serious ill health lump sum will not be possible.
Please note: serious ill health is different to accessing benefits under ill health.

Interaction with the LTA

The payment of a serious ill health lump sum is a BCE (BCE 6) and therefore tested at the point benefits are crystallised, with any benefits above the LTA taxable as a lump sum at 55%. As long as the LTA is not breached, all the lump sum would be paid tax free. The exception to this is where the client is aged above 75, with benefits taxed at the client’s highest marginal rate. This is because a BCE (BCE 5) will have already taken place on the client’s 75th birthday.

IHT implications of transferring whilst in ill health

Firms should be aware that there are some occasions on which a transfer of benefits may give rise to an IHT charge.  For example, where someone is seriously ill and transfers from a defined benefit scheme to deliberately reduce the value of their estate for tax purposes, this could be challenged by HMRC, if the subsequent death of that transferee occurs within two years and their estate is above the IHT threshold.

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Our View

Firms should consider whether a serious ill health lump sum would be an available and reasonable option for the client as opposed to transferring away from the defined benefit scheme. The starting point is to identify whether the factors outlined here (see Qualifying for a serious ill health lump sum) apply. If a serious ill health lump sum is not possible, then this can clearly be discounted as part of the advice. However, where a serious ill health lump sum is possible, consideration should be given as to the suitability of this option rather than a pension transfer. Firms should also be aware that the attractiveness of a serious ill health lump sum is likely to vary dependent upon the scheme.

Action Required By You

Ensure you consider the possible serious ill health option and apply where appropriate.
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About the Author

Paul is a Chartered Financial Planner and is well on his way to a Fellowship. He has a thirst for technical knowledge and, while he advises on all aspects of financial services regulation, he specialises in pensions and investments.

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