Benefit options summary

Taking benefits early due to ill health

Summary

Ill health
An individual’s uncrystallised rights may be paid if the individual is in ill-health at any age.

Severe ill health
An individual's uncrystallised rights may be paid at any age if they are unlikely to be able to do any type of gainful work, other than in an insignificant way, before state pension age or the individual is a member of the UK armed forces who becomes entitled to benefits from the arrangement and those benefits are not taxable.

The annual allowance does NOT apply to contributions in the year benefits are taken from arrangements meeting the above conditions. This is the case for the pension input period ending in the tax year the individual becomes entitled to benefits.

Serious ill health
An individual’s uncrystallised rights may be paid as a lump sum on the grounds of serious ill-health at any age.

The annual allowance does NOT apply to contributions in the year benefits are taken from arrangements meeting the above conditions. This is the case for the pension input period ending in the tax year the individual becomes entitled to benefits.

Conditions

Ill health

• The scheme administrator receives medical evidence from a registered medical practitioner that the individual is, and will continue to be, medically incapable (either physically or mentally) of continuing their current occupation as a result of injury, sickness, disease or disability, and as a result of the ill-health the individual ceases to carry on that occupation.
• Scheme rules may have stricter ill-health criteria. For example, they may state that the individual must be incapable of carrying out any occupation, rather than the current occupation they are in.

Severe ill health

• The scheme administrator accepts evidence from a registered medical practitioner that the individual is unlikely to be able to do any type of gainful work, other than in an insignificant way, before state pension age.
• The individual becomes entitled to all their benefits under that arrangement because they are unlikely to be able to work at any time up to state pension age.

This means the individual is not able to continue in their current job and is not likely to be able to take any other paid work to the extent that this is significant.

For example, the individual could undertake voluntary work or unpaid work where out of pocket expenses are reimbursed or small amounts of travelling or subsistence payments are made.

Any paid work should be insignificant, for example it should be infrequent or only for a few days during the year and the payment must be small in amount, not just as a proportion of previous pay or salary.

Serious ill health

• The scheme administrator has received written evidence from a registered medical practitioner confirming the individual is expected to live for less than one year.
• The individual has not used up all of their lifetime allowance at the point the payment is made. The position where the payment, once made, actually breaches the 100% of the individual’s available lifetime allowance is explained below.
• The payment must extinguish all uncrystallised rights under the arrangement. If no benefits have yet been taken under the arrangement (none have crystallised so far), this means all of the rights in the arrangement must be commuted and paid as a serious ill-health lump sum. If only some benefits have previously crystallised, then the full remainder of uncrystallised rights under the arrangement must be commuted for the serious ill-health lump sum.

Lifetime allowance

Ill health & severe ill health

Benefits are tested against the lifetime allowance as they would be at normal retirement.

Serious ill health

• Before age 75 - Whilst the individual must have available lifetime allowance the level of lump sum paid is not limited by the level of available lifetime allowance. If the lump sum exceeds the available lifetime allowance the excess will be taxed at the individual’s marginal rate of income tax. 
• After age 75 - For the purpose of determining whether the individual has available lifetime allowance, the benefit crystallisation event at age 75 in respect of the uncrystallised pension from which the serious ill health lump sum is to be paid is ignored. Any benefits already taken post age 75 that would have been tested against the lifetime allowance had they been taken before that age are treated as if they had been tested against the lifetime allowance.

Maximum tax-free amount

Ill health & severe ill health

Usually 25% but more can be paid if they have protected tax-free cash.

The full fund has to be crystallised for scheme specific protected tax-free cash to be paid out, benefits cannot be phased.

Serious ill health

• Before age 75 – all tax-free.
• After age 75 - all taxed as pension income at marginal rate.

Income limits

N/A 

What happens at age 75?

Ill health & Severe ill health
N/A

Serious ill health
Benefits taxed at marginal rate.

Minimum age

Ill health
None

Severe ill health
None

Serious ill health
None

Maximum age

None

Tax

Ill health & Severe ill health

• Balance after tax-free cash taxed at marginal rate.

Serious ill health

• Under 75 – tax-free
• Over age 75 - taxed as pension income at marginal rate.

MPAA triggered?

Ill health

If benefits are taken early under ill health by flexibly accessing their pension benefits for example, by taking income from drawdown or by taking an uncrystallised fund pension lump sum, then the money purchase annual allowance will be triggered.

Serious or severe ill health

Taking a serious or severe ill health lump sum will not trigger the money purchase annual allowance.

Small lump sum

Summary

Occupational pension schemes
A lump sum that extinguishes an individual's rights under an occupational scheme or public service scheme.

Non-occupational pension scheme
A lump sum that extinguishes an individual's rights under a non-occupational scheme, for example PP or stakeholder.

Triviality (defined benefit scheme)
A lump sum that extinguishes an individual's rights under a defined benefits scheme.

Conditions

Occupational pension schemes

• The individual isn't a controlling director of the sponsoring employer of this scheme or any related scheme, or connected to a controlling director.
• The payment doesn't exceed £10,000.
• The value of the individual's rights under this and any related scheme doesn't exceed £10,000¹.
• The payment extinguishes the individual's entitlement to benefits under the scheme however an annuity already in payment by the scheme may continue in payment provided the individual has not already received a small lump sum.
• No recognised transfer had been made out of this or any related scheme in the previous three years.

¹ If the scheme is a larger pension scheme, there is no need to include rights under a related scheme. A larger pension scheme is one that has at least 50 members and meets various other conditions (opens in a new window).

Non-occupational pension scheme

• The payment doesn't exceed £10,000.
• The payment extinguishes the individual's entitlement to benefits under the arrangement (not scheme) however an annuity already in payment by the scheme may continue in payment provided the individual has not already received a small lump sum.
• The individual has not previously received more than two payments under these regulations, that means only three payments can be made.

Trivial commutation lump sum (defined benefit scheme)

If the combined value of all of their registered pension scheme benefits is not more than £30,000 on the ‘nominated date’, they can take all of their defined benefits as a lump sum. The value must include the value of any pensions in payment. Individuals do not have to commute benefits under every scheme. They can choose to commute benefits held under one scheme, but not those under another scheme.

Before the benefits can be taken on the grounds of triviality all of the following must apply:

• All benefits taken as a trivial commutation lump sum must be paid within a 12-month period.
• No previous trivial commutation lump sum can have been paid (unless made within the 12-month commutation period)  - trivial commutation payments made before 6 April 2006 can be ignored.
• All of the benefits under a scheme relating to defined benefits, collective money purchase and any in-payment money purchase in-house scheme pension have to be taken.
• The individual must have some lifetime allowance available.

The nominated date must be the first day of the 12-month commutation period or a date three months before.

Lifetime allowance

Small lump sum payments and trivial commutation lump sums are not benefit crystallisation events and are not tested against the lifetime allowance.

Maximum tax-free amount

25% of uncrystallised funds (cannot take more than this even if they have protected tax-free cash).

Income limits

N/A 

What happens at age 75?

N/A

Minimum age

Age 55 or earlier if they have a protected pension age or take benefits early due to ill health. This is increasing to 57 on 6 April 2028.

Maximum age

None

Tax

Where uncrystallised, the individual can receive up to 25% of the lump sum tax free. The rest is eventually payable at the individual's marginal rate of income tax. But depending on the individual circumstances the tax that will be deducted from the payment is as follows:

• Where the lump sum payment is in respect of a pension already in payment the PAYE code already in operation will be used.
• Where the pension being commuted was not already in payment the basic rate (BR) tax code will be used.
• Where the recipient is not UK tax resident the emergency tax code will be used.

If the individual thinks they have paid too much or not enough tax, then they will need to discuss this with HMRC.

If a pension in payment is commuted and taken as a trivial lump sum none of the trivial lump sum will be tax free.

MPAA triggered?

No

Lump sums

Summary

Uncrystallised funds pension lump sum (UFPLS)
A lump sum which can be taken from a pension fund which is uncrystallised.

Partial uncrystallised funds pension lump sum
Although this is not drawdown it can achieve a similar result as phased drawdown. The individual crystallises the amount required each year, each UFPLS will be paid with 25% tax free with the rest taxed income. Not all plans allow partial UFPLS.

Conditions

To use this option the individual can't have primary or enhanced protection with registered tax-free cash nor can it be paid from an arrangement that contains a disqualifying pension credit (a pension credit in relation to a divorce which originates from previously crystallised funds). They must also have available lifetime allowance:

• Those under age 75 will need the whole of the UFPLS to be within their lifetime allowance. Where the amount crystallising exceeds the available lifetime allowance the excess can still be paid as an authorised lump sum payment as a lifetime allowance excess lump sum.
• Those over age 75 only require part of the UFPLS to be within their remaining lifetime allowance however any amount in excess of the lifetime allowance will be taxed at their marginal rate of income tax.

Lifetime allowance

Benefits are tested against the lifetime allowance as they would be at normal retirement.

Maximum tax-free amount

25% of uncrystallised funds (cannot take more than this even if they have protected tax-free cash).

Income limits

N/A 

What happens at age 75?

N/A

Minimum age

Age 55 or earlier if they have a protected pension age or take benefits early due to ill health. This is increasing to 57 on 6 April 2028.

Maximum age

None

Tax

• Below age 75 - 25% of the value of the UFPLS will be tax free. 75% of the value of the UFPLS will be added to the individual's taxable income in that year and taxed accordingly.
• Over age 75 - 25% of the lower of the value of the UFPLS and the available lifetime allowance is tax free.  The balance will be added to their taxable income in that year and taxed accordingly

MPAA triggered?

Yes

Secure pension

Summary

Lifetime annuity
This can be bought from an insurance company and is not restricted to the company providing the pension plan (OMO).

Scheme pension
This can be paid directly from the scheme assets or secured through an insurance company.

A scheme pension is the only way a defined benefit scheme or collective money purchase scheme can pay out scheme pension benefits.  A defined contribution scheme can pay out a scheme pension or, more commonly, a lifetime annuity, as an alternative to drawdown or UFPLS. 

Conditions for paying a lifetime annuity

Individuals can select either an annuity guarantee (term certain) period or annuity protection. There is no maximum guarantee period for a lifetime annuity, but conditions may apply.

Annuity protection allows a lump sum to be paid out on death. The maximum amount that can be paid is based on the difference between the annuity purchase price less income payments already paid.

It is also possible to provide a beneficiary's annuity that will be paid on the death of the individual.

Testing against the lifetime allowance

Lifetime annuity
The value of benefits used to purchase the annuity plus any tax-free cash is tested against the lifetime allowance.

Scheme pension
20 x the annual scheme pension, plus any tax-free cash not payable by commuting scheme pension.

Maximum tax-free amount

Usually 25% but more can be paid if they have protected tax-free cash.

Income limits

N/A 

What happens at age 75?

N/A

Minimum age

Age 55 or earlier if they have a protected pension age or take benefits early due to ill health. This is increasing to 57 on 6 April 2028.

Maximum age

None

Tax on lifetime annuity benefits

Annuity - After the tax-free cash has been paid the balance is payable at the individual's marginal rate of income tax. 

Annuity guarantee (term certain) - Where the individual dies after becoming entitled to a lifetime annuity, and payments continue under the contract because of a guarantee, the recipient of the continued payments will generally receive the payments tax free, if the deceased was under age 75 when they died or they will pay tax at their marginal rate of income tax, if the deceased was age 75 or over when they died.  

Annuity protection - This lump sum is called an annuity protection lump sum death benefit. If the individual dies before age 75 the lump sum is paid tax free, if they die after age 75 it is taxable at the recipient’s marginal rate of income tax.

MPAA triggered?

No

Drawdown

Summary

Short-term annuity

Where an individual becomes entitled to a fixed-term annuity, it qualifies as a short-term annuity for the purposes of the tax rules if it is:

• Bought by the application of sums or assets representing all or part of the individual’s drawdown pension fund.
• Payable by an insurance company, and
• Payable for a term not exceeding 5 years.

Flexi-access drawdown

Since 6 April 2015, when an individual first designates funds under an arrangement to provide drawdown, it will be set up as flexi-access drawdown. On 6 April 2015, all existing flexible drawdown plans automatically converted to flexi-access drawdown plans.

Flexi-access drawdown involves taking income directly from a fund instead of buying an annuity.

If an individual in capped drawdown takes more than the maximum income their plan is converted to a flexi-access drawdown plan.

Capped drawdown

Capped income drawdown also involves taking an income directly from a fund instead of buying an annuity. They could only be set up before 6 April 2015 (although a new one still can be set up to receive a capped drawdown transfer). Unlike flexi-access drawdown, there is a limit on the maximum amount of income that can be withdrawn during a year and this limit is reviewed on a frequent basis.

Phased drawdown

This is when a combination of tax-free cash and income is used each year to provide the required income. Only the amount needed to provide the income is moved into income drawdown, the balance remains uncrystallised. Assuming the individual doesn't require the maximum permitted tax-free cash at the start, this combination provides maximum flexibility. This is sometimes referred to as drip feed drawdown were done on an automated basis. 

Conditions

Short-term annuity

To be a short-term annuity, the annuity must be:

• Bought by the application of sums or assets representing all or part of the individual’s drawdown pension fund.
• Payable by an insurance company, and
• Payable for a term not exceeding 5 years.

Lifetime allowance

The value of benefits taken are tested against the lifetime allowance.

Maximum tax-free amount

Short-term annuity
None as tax-free cash paid when benefits are crystallised.

Flexi-access drawdown/capped drawdown
Usually 25% but more can be paid if they have protected tax-free cash and all of the fund is crystallised at the same time. If someone has registered tax-free cash in connection with enhanced or primary protection, their maximum tax-free cash amount may be higher (or even lower) than 25%.

Phased drawdown
25% of the value being designated. Any protected tax-free cash protection will be lost as not all benefits under the scheme being taken at the same time.

Income limits

Short-term annuity

If bought by a flexi-access drawdown fund, there is no upper limit on the amount a short-term annuity can pay.

However, where a short-term annuity is bought using funds from a capped drawdown pension fund there is an upper limit on the amount of short-term annuity that can be paid. The amount payable from a short-term annuity contract plus the amount of any income withdrawal from the capped drawdown pension fund in a pension year cannot be more than the maximum drawdown pension.

If the individual is taking capped drawdown their maximum drawdown pension will be reviewed:

• at least every three years if they are under 75, and 
• every year when they are 75 or older

So, in considering the length and amount of a short-term annuity contract the individual may buy, they need to remember that their maximum drawdown pension could change part way through the term of the annuity. If their maximum drawdown pension goes below the amount payable by their short-term annuity contract the excess amount will be an unauthorised payment.

Flexi-access drawdown

The remaining fund after tax-free cash has been paid will be designated to provide drawdown, which may be taken as a regular income, as a single lump sum or on an ad hoc basis as required. The amount that can be withdrawn is not subject to income limits; however, any amounts withdrawn will be added to the individual’s taxable income in that year. There is no minimum income requirement. Individuals in flexi-access drawdown may continue to make contributions; however, if they take any income, they will be subject to the money purchase annual allowance of £10,000.

Capped drawdown

The maximum amount of income that can be taken during a 'pension year' is 150% of the Government Actuary's Department (GAD) relevant annuity with no guarantee.

Phased drawdown

The remaining fund after tax-free cash has been paid will be designated to provide either capped drawdown or flexi-access drawdown, which may be taken as a regular income, as a single lump sum or on an ad hoc basis as required.

If capped drawdown, the maximum amount of income that can be taken during a 'pension year' is 150% of the Government Actuary's Department (GAD) relevant annuity with no guarantee.

If flexi-access drawdown the amount that can be withdrawn is not subject to income limits; however, any amounts withdrawn will be added to the individual’s taxable income in that year.

Individuals in flexi-access drawdown may continue to make contributions; however, if they take any income they will be subject to the money purchase annual allowance of £10,000. The money purchase annual allowance isn’t triggered by withdrawals from a capped drawdown plan within the cap.

What happens at age 75?

Short-term annuity

The annuity does not have to come to an end when the individual reaches age 75.

Flexi-access drawdown

Reaching age 75 is a benefit crystallisation event (BCE) and so the drawdown fund will be tested against the lifetime allowance. Obviously, going into drawdown in the first place was also a BCE so, to avoid 'double counting' against the lifetime allowance, the amount originally crystallised when the individual went into drawdown is deducted. Only the balance (if any) counts as an additional BCE amount.

Capped drawdown/phased drawdown

Reaching age 75 is a benefit crystallisation event (BCE) and so the drawdown fund will be tested against the lifetime allowance. Going into drawdown in the first place was also a BCE so, to avoid 'double counting' against the lifetime allowance, the amount originally crystallised when the individual went into drawdown is deducted. Only the balance (if any) counts as an additional BCE amount.

For capped drawdown the review dates also change - the maximum drawdown pension will now need to be recalculated at the start of every pension year. The switch over to yearly reviews will happen at the end of the pension year following the individual's 75 birthday.

Minimum age

Age 55 or earlier if they have a protected pension age or are taking benefits early due to ill health. This is increasing to age 57 on 6 April 2028.

Maximum age

None

Tax

Tax is payable at the individual's marginal rate of income tax.

MPAA triggered?

Short-term annuity
Yes, if bought by a flexi-access drawdown plan but not if bought by a capped drawdown plan.

Flexi-access drawdown
Yes, but only when income commences.

Capped drawdown
No

Phased drawdown
Yes, but only when income starts from a flexi-access drawdown plan.