What is Phased Retirement?

Phased Retirement is a means of taking retirement benefits with the main objective of providing a greater degree of control and flexibility over your pension fund.

Phased Retirement is an extremely flexible and tax efficient way of providing an income in your retirement.  You control how much income you receive, in what form and how the remaining pension fund is invested.

When can it be used?

Phased Retirement is generally used by those who do not require a tax free lump sum (also known as Pension Commencement Lump Sum or PCLS) but do require a flexible income from their pensions.

How it works

Benefits may commence at anytime between the ages of 55 and 75.

For those who have built up sufficient provision to meet their retirement goals taking benefits at 55, which is earlier than a traditional retirement age, should not cause financial hardship. However taking retirement benefits early is unsuitable in many circumstances and will reduce income in retirement.’

Before drawing early on your pension to meet a specific financial need other than retirement income you should consider firstly accessing other savings and investments as alternative sources of funding.

Typically all pension funds are brought together into one personal pension consisting normally of anything between 100 and 1,000 separate but identical segments, which can be drawn on as required.

In the first year of retirement you decide on the level of income that you require and the provider calculates the amount needed to provide for the chosen level. Normally up to 25% of each pot of money can be taken as a tax free cash sum, with the remaining balance providing an income via a Lifetime Annuity or Income Drawdown.

The remaining segments not needed to produce an income are left invested until required. They are invested as per the instructions of you or your adviser.

In the second year you decide how much income is needed, after taking into account the income already being received from the Lifetime Annuity or the Income Drawdown arranged in the first year.

Again in the second year income consists of a tax free cash sum and a Lifetime Annuity or Income Drawdown.

It is possible to vary the type of Lifetime Annuity or Income Drawdown selected on each occasion and it need not be on the same basis as the first or subsequent years.

In each subsequent year the same process is repeated allowing you to take account of changing personal and family circumstances.

It used to be the case that by the time you reach age 75 any remaining segments had to be used to provide a tax free cash sum and a Lifetime Annuity. However from 6th April 2011 the rules will change meaning that income does not have to be secured by age 75.

Compared to a conventional Lifetime Annuity, where the basis of income is fixed at outset and cannot be changed, Phased Retirement allows more flexibility with income being varied according to changing needs.

The benefits paid when you die will normally comprise two elements:

First, each time you buy a Lifetime Annuity you can arrange for it to continue to be paid to your spouse when you die, at the same or a lower level. In this way, as over the years, more of the Phased Retirement plan is used to purchase Lifetime Annuities, a guaranteed income for your spouse is built up. The income paid to your spouse will be liable to income tax, which will be collected at source from the annuity provider

Second, those segments that have not been used when you die will be paid to your estate, normally as a lump sum. Usually, there will be no tax to pay on the lump sum and it will not be included in your estate for inheritance tax purposes

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 i.e. the segments not cashed in or ‘vested’ continue to be invested in a tax efficient environment, thus providing you with the possibility of higher future income.  This depends largely on how much income you take out of the pension fund 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 mainly due to the fact that Annuity rates are better for someone aged say 70 rather than 60. Of course any rise in Annuity rates due to your age could be eroded by rates in general falling
  • If medium to long-term interest rates and gilt yields rise, then Annuity rates might also rise.  If this happens, you will be able to achieve a higher amount of income if you eventually purchase an annuity
  • If your health deteriorates you would be able to take advantage of an enhanced or impaired life annuity with the rest of the fund which could provide you with significantly more income
  • You will be able to change the shape of your retirement income to reflect your personal circumstances in the future, although once you have purchased an annuity, this income payment will continue for the rest of your life
  • The remaining pension fund, i.e. the policies not cashed in or ‘vested’ can be returned to your beneficiaries normally free of Inheritance Tax on your death

Disadvantages

  • If you plan to purchase a Lifetime Annuity in the future deferring the date of this purchase does not guarantee a higher level of future income, as Annuity rates can go down as well as up and the value of the continued investment of your pension fund may go down as well as up
  • The value of your remaining pension fund, when aggregated with any Annuity you have purchased, may not achieve the required level of growth to provide an income at the same level as that which could have been achieved through the purchase of a conventional Lifetime Annuity at outset
  • The sections of your pension fund not used to purchase an Annuity will continue to be exposed to the risks of investment
  • You may feel that the prospect of future higher income does not compensate you for not being able 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 using the cash to supplement your income
  • Annuity providers make a profit from the fact that some individuals die sooner than expected.  They utilise some of this ‘mortality profit’ to enhance current annuity rates.  By delaying the purchase of your annuity, the benefit of this potential profit, which can be significant, will be lost
  • The advice and administration costs will generally be higher than under Lifetime Annuity purchase

Next steps

Making the decision as to how your pensions will generate an income requires careful consideration and full knowledge of all the options available to you.

We firmly believe that when considering such an important area of your financial planning, Independent Financial Advice is crucial.

At Investment Sense we offer initial meetings with no cost or obligation.

Call us today on 0845 074 778 or 0115 933 8433 to speak with an adviser, alternatively email info@investmentsense.co.uk