It is also possible to combine Phased Retirement with Drawdown Pension which would mean that you would start to draw an income from just part of your pension fund on one date including the tax free cash sum available from that part, leaving the rest of the fund intact.

To increase your income at a later date, you could either increase the rate of withdrawal (provided you did not exceed the maximum limit if using Capped Drawdown) or start to draw an income, including the tax free cash sum, from a further slice of your pension fund.

Each time you start using a segment (or portion of your pension fund) for Drawdown Pension, you can first take part of the portion’s fund as tax-free cash (normally 25% of the portion).

Using Your Tax Free Cash Effectively

Converting portions of the fund regularly, for example once a year, means you can effectively use the tax-free cash, as well as the Drawdown Pension payments, to provide your income. The drawback is that if you stagger the conversion of your pension fund into Drawdown Pension, you will not be able to take all your tax-free cash from your total pension fund at once as a single lump sum.

Phased retirement can be a very useful financial planning tool, for example, if you want to ease back gradually on work and start to replace your earnings with pension income. It also provides more flexible help for your survivors if you die. On death, the balance of the pension fund that has not yet been used for Drawdown Pension can provide a pension for your surviving dependents or a lump sum, depending on the terms of the pension plan.

Phased retirement is generally suitable only if you have a fairly large pension fund, or have other assets or income to live on. This is because the bulk of your pension savings remain invested, usually in the stock market, which may be more risky than buying an annuity straight away.

Phased retirement advantages

•  You can use tax free cash as ‘income’ and thus, for a given level of income, reduce your overall liability to Income Tax.
•  The balance of your pension fund not used for Drawdown Pension continues to be invested, thus providing you with the possibility of higher future income. This depends largely on how much income you take out of the pension fund (especially in the early years) and future investment returns achieved on the residual pension fund.
•  As you get older there is the prospect of annuity rates rising and providing you with higher income. This is because life expectancy is shorter for someone older and it therefore costs less to provide them with the same given level of income than for a younger person, assuming all other things being equal.
•  If your market expectations are that medium to long-term interest rates and gilt yields may rise, annuity rates might also rise. If this happens, you will be able to achieve a higher amount of income, through the purchase of an annuity, for the same amount of pension fund.
•  You will be able to change the shape of your retirement income to reflect your personal circumstances in the future. Should your health deteriorate, it may be possible to achieve a better annuity rate (ie. higher income) in future. It is also possible to postpone the choice of whether to include any spouse/dependents pensions until a lifetime annuity is purchased – this could be valuable for someone whose spouse is in poor health.
•  If your market expectations are that medium to long-term interest rates and gilt yields may rise, annuity rates might also rise. If this happens, you will be able to achieve a higher amount of income, through the purchase of an annuity, for the same amount of pension fund.
•  Any remaining pension fund that has not been used for Drawdown Pension can be returned to your beneficiaries as a lump sum normally free of Income Tax and Inheritance Tax on your death before age 75. On death after age 75, an income tax charge of 55% will be due on the value of the remaining fund (unless paid to charity) but there should be no liability to Inheritance Tax. Funds used to provide a dependents annuity will not be subject to the 55% tax charge – the annuity will however be taxed as income in the hands of the dependent(s).

Phased retirement disadvantages

•  There is no guarantee that your income will be as high as the income available under the Lifetime Annuity routes referred to earlier.
•  Deferring the purchase of the annuity does not guarantee a higher level of future income and the value of your remaining pension fund, when aggregated with any income you have taken, may not achieve the required level of growth to maintain income levels at the same level as could be achieved through the purchase of a conventional Lifetime Annuity with the entire pension fund (excluding tax free cash) at outset. This is because withdrawals of tax free cash and income withdrawals may erode the value of your pension fund if investment returns are not sufficient to make up the balance (including charges for the ongoing administration of the plan).
•  You may feel that the possibility of future higher income does not compensate you for being unable to enjoy a guaranteed and secure level of income today and for the rest of your life.
•  You will not receive all of your tax free cash as a lump sum at outset, because you are accessing your pension fund gradually over time and using the cash to supplement your income.
•  Annuity providers make a profit from the fact that some individuals die sooner than is expected. They utilise some of this ‘mortality profit’ to enhance current annuity rates. By delaying the purchase of annuities the benefit of this potential profit, which can be significant, may be lost.

Advice Tailored to Your Circumstances

When approaching retirement around 55% of people simply accept the first offer their pensions company sends them. Although it probably doesn’t take into account their health and lifestyle or inflation, that contract is legally binding for the rest of their lives. We don’t think signing it is a smart move. Contact us now for individual advice tailored to your circumstances.