Drawing an Income from a Pension for those in poor health

Derby District & Law Society (D& DLS) magazine – May 2011

The Importance of Pension Planning – Part Three

Drawing an income from a Pension for those in poor health or terminally ill

In this article we look at how to get maximum value out of a pension for an individual who is suffering from poor health or is terminally ill and how their Pension can also be used to provide for their loved ones.

Under current legislation, benefits can be drawn from age 55, however, there are two ways in which Pension benefits can be accessed earlier, depending on the severity of illness:

Serious ill health commutation – this is only available if life expectancy is under one year (must be certified by a medical practitioner). The entire Pension fund is paid as a lump sum that is free of tax provided the value of all pensions owned is under £1.8m (2011/12 tax year).

Ill health early retirement – this is available if a medical practitioner can certify that the pension member is incapable of carrying out their own occupation (or sometimes any occupation, depending on the scheme rules) and they are not expected to return to work in the future.

A member of an occupational Defined Benefits (or Final Salary) scheme will receive Tax Free Cash plus a scheme pension for life (subject to Income Tax) and for the life of their spouse, if selected.

For a member of an occupational Defined Contribution (or Money Purchase) scheme, or any type of Personal Pension, there are a number of ways in which benefits can be drawn. The most suitable way to draw benefits of course depends on an individual’s own circumstances and objectives. Some of the main options are detailed below (please note this list is not exhaustive of all of the options available or advantages and disadvantages!):

Income Drawdown

This is typically only suitable if generating guaranteed income is not a key objective and taking risks with the Pension fund is acceptable.

Advantages:

25% Tax Free Cash can be taken. The residual fund remains invested for growth.

On death, the Pension can pay out the value of the fund (less 55% tax) or the surviving spouse can use the whole fund to secure an income for himself/herself.

Annuity Rates typically increase with age and deteriorating health, so delaying the purchase of an Annuity can mean a higher annuity income can be obtained.

Disadvantages:

This is a high-risk strategy, especially if a high level of income is taken (could possibly exhaust the fund). 

There are costs incurred for managing Income Drawdown (regular reviews are required) and there are usually high charges on the Drawdown contracts.

The purchase of an annuity might be delayed to a time when Annuity Rates are lower (Annuity Rates are declining because people are living longer).