What should you do with your pension if you fall very ill?

Falling too ill to provide for yourself and your family is a devastating personal blow, and can very likely throw your finances into disarray too.

It will be little consolation for the loss of your health, but there are ways to use your pension pot to relieve money troubles should you find yourself in this sad situation.

The two main ways to do this are by gaining early access to your pension savings and by taking advantage of any enhanced benefits available from your scheme or the taxman.

Pension advice: Contact your present and all your past pension schemes to explain your medical situation and find out about any enhanced benefits

There are a host of different factors that will determine how much leeway you have to draw on your pension, slash your tax bill or boost bequests to loved ones.

These include your age, how ill you are, and whether you have a guaranteed final salary pension or a defined contribution pot that is invested to provide for your retirement needs.

Here we offer a round-up of your pension options if you fall very ill. However, pension experts stress that it is wise to get financial advice should you find yourself in these circumstances.

This is particularly the case if your personal affairs are complicated, you have dependants to take care of, or you have a sizeable pension pot.

Ill health: No longer fit to work

* How ill are you? If you have a workplace or personal pension you may be able to access an income or lump sum at any age. But to be able to do that before age 55 you will need to get qualified medical advice confirming that you are too ill to continue in your current job and have ceased to carry on that occupation, according to Jon Greer, head of retirement policy at Quilter. 

‘It is important to check the rules of the pension scheme as some may have a stricter ill-health definitions than others, for example requiring the member to be incapable of carrying out any occupation.’

* How old are you, and how does this affect your tax bill? ‘If a person is in ill health it is possible to take their pension benefits regardless of their age at the time,’ says Greer.

Normally, you can’t access your retirement savings before the age of 55 without facing a swingeing tax bill.

But if you are ill and aged under 55, you can take your pension under the same tax rules as over-55s. This means you can get 25 per cent tax-free, while the rest is taxed at your income tax rate of 20 per cent, 40 per cent or 45 per cent.

* What if you have a defined contribution pension? You can take your pot and spend, save or invest it as you wish, but your choices might be different than if you were in good health.

For instance, you might not be interested in having a guaranteed income until you die if you don’t expect to live long, or in investing to eke out your money as long as possible. Instead, you might have a greater short-term need for cash, or want to arrange your affairs to maximise bequests.

New rules: Trustees of a final salary pension scheme are permitted to pay the pension early in some cases 

* What if you have a final salary pension? This traditionally generous type of work pension provides a guaranteed income for life.

Greer says: ‘The trustees of the pension scheme are permitted to pay the pension early without any reductions made for early payment. However, it is extremely important to get in contact with the scheme to find out what the trustees of the scheme are willing to offer.

‘If your defined benefit scheme allows you to take your pension early then they may still be able to reduce or stop it at any time if you subsequently recover or partially recover from ill-health.’

* What if you expect your health to worsen significantly? Independent pensions expert Alan Higham, formerly retirement director at Fidelity Worldwide Investment, cautions that you might save more tax if you delay touching your pension.  

This is because people whose doctors give them just one year to live get more favourable tax treatment, but not if they have already accessed their pension, he explains. See below for more details.

Serious ill health: Less than a year to live

* How ill are you? ‘If a person is suffering from serious ill-health it is possible for them to take all of their pension benefits as a lump sum payment,’ says Greer.

‘Before making the payment the pension scheme must have received written evidence from a registered medical practitioner confirming that the person is expected to live for less than a year. The lump sum payment can only be made in respect of unused pension funds, known as uncrystallised funds.’

Terrible news: Falling too ill to provide for yourself and your family is a devastating personal blow, and will very likely throw your finances into disarray too

* How old are you, and how does this affect your tax bill? ‘There is no tax to pay on the lump sum if the person is under the age of 75, as long as they have enough available lifetime allowance to cover the payment,’ says Greer.

The lifetime allowance is currently £1,073,100. Anything in your pension pot above the limit is hit with a 55 per cent tax charge.

Greer adds: ‘A serious ill health lump sum paid to a person who has reached the age of 75 is subject to income tax at marginal rates (20 per cent, 40 per cent or 45 per cent depending on the size of the payment). As an alternative, they could consider taking their pension fund as a lump sum using flexi-access drawdown.

‘This means up to 25 per cent of the lump sum could be taken as tax-free cash and the remainder subject to income tax at their marginal rate.’

* What if you have a defined contribution pension? ‘If you are in serious ill health, meaning you’re unlikely to live for 12 months, then the whole amount of your pension can be released as a lump sum tax free,’ says Higham.

You must be aged under 75, he adds.

Jon Greer: ‘If a person is suffering from serious ill-health it is possible for them to take all of their pension benefits as a lump sum payment’

* What if you have a final salary pension? This will depend on whether you are still actively paying into the pension, or if it is frozen after you left a previous employer, says Higham.

If you are actively contributing, your money can be released without any reductions, but if it is frozen then you won’t get the full amount.

In the latter case, it might be better to find out the transfer value of your pot and take it elsewhere instead. See below for more details.

Greer says that trustees might allow a person to commute their pension for a serious ill-health lump sum, which can benefit some people.

But he cautions: ‘Spouses, civil partners and other dependants are typically entitled to some income from the scheme following the death of the scheme member. So it is important to check what’s on offer.’ 

Should you transfer your pension pot?

* What if your final salary pension is too restrictive given your illness? For someone with a shortened life expectancy due to ill health, they may consider whether a transfer out of the final salary scheme is in their best interest

Greer warns that anyone with a final salary pot worth more than £30,000 must take advice from a professional independent financial adviser before they are allowed to transfer it.

‘Whether taking advice or not, it is very important to think through your options carefully because in some cases, actions taken to improve the efficiency of pension savings, particularly in the case of ill-health, could lead to some unintended repercussions.’

* Are there any other inheritance obstacles? ‘In most circumstances, inheritance tax no longer applies to death benefits paid by pension schemes, whether paid as lump sums or income,’ says Greer.

‘However, any money taken out of the pension becomes part of your estate, which means it could be subject to inheritance tax. In addition, if you transfer pension rights from one pension scheme to another, perhaps because another scheme offers greater benefits on death, then HMRC would deem that they made a fresh disposition of their death benefits.

‘This is a transfer of value for IHT purposes, and could create a potential IHT liability on death if the member’s life expectancy was impaired when they made the transfer and they died within the following two years.

What about my state pension – can I get that early due to ill health?

No. The earliest age you can receive the state pension is your state pension age. But if you retire early because of ill health, you may be entitled to other benefits like universal credit, statutory sick pay or employment and support allowance. 

There are calculators on the Gov.uk website that will tell you what benefits you could get.

For people with terminal illness there are special rules that may mean you get benefits at a higher rate and get payments quicker than usual. 

These fast-tracked benefits will be extended on 4 April 2022 to those expected to die within a year, from just six months in the past, so that more people get support they need when they need it most. 

What do the experts say?

Should you fall seriously ill, Alan Higham advises contacting your present and all your past pension schemes providers to explain your medical situation and find out what you’re entitled to, because the benefits they offer will probably vary in each case.

‘There are options and choices you need to work through,’ he says. ‘It’s just a very complicated issue. A lot depends on medical details. What one pension scheme will accept another might not. You might have to fight your corner. You shouldn’t expect it to be an easy ride.’

Jon Greer says that in addition to looking into their pensions, people in bad health should also check what income they might still get from employers, any state benefits they might be entitled to, and whether they hold insurance policies that might pay out.

Care needs to be taken as if you access your pension, as it may affect your eligibility for state benefits or payments from income protection insurance if you have it, he adds. 

As noted above, should you decide to transfer a final salary pension pot worth £30,000-plus as a result of illness, you will be required to consult a financial adviser, but Greer reckons it’s a ‘no brainer’ to do this whether compulsory or not.

‘This can be a quite complex area in terms of family, care costs and providing for dependants,’ he says.

This post first appeared on Dailymail.co.uk