‘Serious Ill Health Lump Sums’ (SIHLS) Frequently Asked Questions

  • What are the conditions for paying pensions benefits as a lump sum due to ill health?

    Dalriada’s John Wilson and Ian Craig look at some frequently asked questions about SIHLS on this video.

    John also wrote some answers to Frequently Asked Questions about the topic SIHLS.

    ‘Serious Ill Health Lump Sums’ (SIHLS) Frequently Asked Questions

    What are the conditions for paying pensions benefits as a lump sum due to ill health?

    Payment of a SIHLS means that all of a member’s pension benefits are commuted and paid to him/her as a single lump sum in full discharge of their entitlement under the scheme (but not necessarily the entitlement of their spouse, as explained below).

    Is a SIHLS an authorised payment for tax purposes?

    Yes, subject to meeting certain conditions.

    Under the Finance Act 2004 (FA 2004), Sch 29, para 4, a scheme administrator may commute the whole of a member’s pension entitlement into a lump sum, known as a SIHLS, if the following conditions are satisfied:

    1. Before it is paid, the scheme administrator has received evidence from a registered medical practitioner that the member is expected to live for less than one year. (The term ‘registered medical practitioner’ refers to a person who is registered under the Medical Act 1983 or, where the member in serious ill-health is overseas, a person with equivalent overseas qualifications.)
    2. All or some of the member’s lifetime allowance is still available. The amount of the SIHLS is not limited by the amount of lifetime allowance left. If the SIHLS sum exceeds the member’s lifetime allowance, the excess would become subject to a lifetime allowance charge equal to 55% of the excess. In practice, the scheme administrator would usually pay the SIHLS net of any lifetime allowance charge due, provided the scheme rules allow for this.
    3. The payment must extinguish all uncrystallised rights under the arrangement. If some benefits have previously crystallised, a SIHLS may still be paid provided it is paid in respect of all the remaining uncrystallised rights within the arrangement.

    If these conditions are satisfied, the SIHLS will be an ‘authorised payment’.

    Is a SIHLS subject to income tax or any other taxes?

    A SIHLS paid to a member below the age of 75 will be received free of income tax, subject to the lifetime allowance limit. If the lifetime allowance limit is exceeded, a lifetime allowance charge of 55% will apply to the excess.

    If the recipient of the SIHLS has reached the age of 75, the lump sum is taxable at the individual’s marginal rate of income tax.

    Where a tax charge occurs, the scheme administrator will usually deduct it from the SIHLS before paying that lump sum over to the member, provided the scheme rules allow for this.

    A SIHLS paid to a member who has reached the age of 75 will not count towards the member’s lifetime allowance, although it will still be necessary to establish that at least some of the member’s lifetime allowance is available at the time of payment.

    The Scheme Administrator must report the payment to HMRC SPSS if either:

    • the recipient of the payment is –
      • a director of the sponsoring employer of the scheme in the year of payment (or has been in the previous six years), or
      • connected to such a director in the same period, or
      • alone or with others, represented the sponsoring employer in that time, or
      • connected to that employer; or
    • the member is relying on either an enhanced lifetime allowance entitlement, or an entitlement to enhanced protection or any form of fixed or individual protection, to reduce or eliminate a liability to a lifetime allowance charge on the payment of the SIHLS.

    A scheme administrator may incur penalties for any failure to report a SIHLS.

    How should a SIHLS be calculated?

    Under a money purchase arrangement, the SIHLS will be equal to the funds held in that arrangement in respect of the member.

    Under a defined benefits arrangement, the SIHLS will be equal to the capital value of the member’s pension benefit entitlement under that arrangement. How that capital value is calculated will be for the scheme / its rules to decide. In practice, the scheme actuary will use a formula consistent with other actuarial calculations made in respect of scheme benefits; e.g. the member’s cash equivalent transfer value (CETV) but excluding spouse pension (see below).

    NB The legislation permitting the payment of a SIHLS does not override a scheme’s trust deed and rules. Trustees may only make such payments in accordance with the provisions of their scheme’s trust deed and rules. In practice, most scheme rules do allow for such payments.

    Are there any other SIHLS requirements?

    Yes, if a scheme was a formerly contracted-out scheme and the member in question has accrued rights to Guaranteed Minimum Pension (GMP).

    Even where a member is entitled to contracted-out rights (whether a GMP or contracted-out salary related rights accrued on or after 6 April 1997 (‘section 9(2B) rights’), it is possible to commute those rights, as well as other main scheme benefits, into a SIHLS.

    There is though an exception if the member has a spouse or civil partner who, on the member’s death, would be entitled to a survivor’s pension in respect of those contracted-out rights. In that case, legislation requires the scheme to retain such amount as is necessary to be able to pay that survivor’s pension.

    Since one of the conditions for the payment of a SIHLS is that the member’s entitlement to benefits under the relevant arrangement has to be extinguished, then the dependants’ benefits would have to be moved to a separate arrangement either before or at the time a SIHLS is paid. This requires no more than documenting the creation of a new arrangement in a manner which is considered acceptable under the scheme.

    What's the impact of SIHLS on ancillary benefits

    Receipt of a SIHLS may have the effect of reducing a member’s life cover as that member will then cease to be an active member. This was the subject of the Pensions Ombudsman determination Mrs T (PO-19080) in which the Ombudsman concluded that neither the employer nor the administrator were required to warn the member of the impact of the SIHLS on his life cover and that, in any event, such a warning would have amounted to the giving of financial advice which the employer was not authorised to give and the administrator was not instructed to provide in the circumstances.

    SIHLS and GMP equalisation

    In July 2020, HMRC published a GMP equalisation newsletter to address possible issues that may arise as a result of schemes equalising benefits for GMPs. The guidance applies once a particular scheme has adopted its chosen GMP equalisation method.

    HMRC has confirmed that the requirement that a SIHLS must extinguish all of the member’s uncrystallised rights under the arrangement applies to all of the uncrystallised rights that could reasonably have been known about at the time of the payment.

    This means that a previously paid SIHLS will not represent an unauthorised payment if, purely because of GMP equalisation, a further entitlement for the member is subsequently identified that the scheme could not reasonably have known about at the time of the original payment.

    For future lump sums, once a scheme has adopted its chosen GMP equalisation method, it may either identify that a “top up” payment is due to a member who has previously received a SIHLS, or pay out a SIHLS to a member who has not received a previous payment (a “new payment”). HMRC has confirmed that, in either case, for the payment to be authorised, it must meet SIHLS payment conditions in force at the time the top up or new payment is made.

    Schemes making a “new payment” will need to take account of any GMP equalisation adjustments when calculating and paying the SIHLS.

    Schemes wishing to make a “top up” SIHLS payment should note that it is not possible to make such a payment after the member’s death. It may, however, be possible for the scheme to classify a “top up” payment due after the member’s death as a different type of authorised payment such as a small lump sum.

    Schemes in Pension Protection Fund (PPF) assessment

    Whilst a scheme is in a PPF assessment period, the benefits payable must be restricted to the level of PPF compensation that would be due if the scheme had actually fallen into the PPF.

    The PPF compensation provisions allow for the payment of a “terminal illness lump sum” where “the person suffers from a progressive disease and the person’s death in consequence of that disease can reasonably be expected within 6 months”. Note that the conditions here are rather more restrictive than the requirements for the payment of a SIHLS.

    A terminal illness lump sum is calculated as twice the sum of the periodic compensation annual amount plus the lump sum compensation annual amount.

    State benefits that may be commuted on terminal illness

    Whilst it is not our duty to advise members, it would be good practice when providing members with the SIHLS option to recommend that they consider seeking advice or guidance. Other benefits outside of the scheme may also be available when a member is seriously ill. For example, whilst there is no State benefit specifically designed to help people who are terminally ill cope with the financial impacts, there are rules in place which allow simpler and faster access to certain benefits:

    • Benefits designed to help with the additional costs of disability and ill health – Disability Living Allowance, Personal Independence Payment, and Attendance Allowance
    • Income replacement benefits for people whose ability to work is affected by disability or ill health – Employment and Support Allowance and Universal Credit.
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