3. Phased Retirement

How does it work?

Phased retirement allows you the flexibility to take benefits from personal pension funds in stages, leaving the balance of funds invested. There may be a number of reasons for doing so. For example, you may wish to ease into retirement and work shorter hours. This option would allow you to take a low level of income initially, and increase it later as you spend less time at work. It may be possible, depending on how your plan is set up, to continue to make contributions, subject to Inland Revenue limits.

Your pension fund is split into a number of equal segments (typically 1,000) and this allows you to use just some of the segments to buy your pension, leaving the remainder invested until required. However, please note that HM Revenue & Customs rules now permit partial encashment of a single policy as long as the scheme rules allow for this. The segments can be encashed for annuity purchase over a number of years until age 75, at which time a final annuity must be purchased.

You determine how much of your income is required for the first year and the pension company calculates what proportion of the fund is required to provide this level of income (i.e. how many segments need to be encashed). When you take income by encashing segments, you have the option to take up to 25 % of the value as tax-free cash and the balance is used to buy an annuity.

In subsequent years, you will continue to receive income from the annuity or annuities purchased. If additional income is required further segments from the pension fund can be encashed, again using up to 25% of the value as tax-free cash. This process may continue to the age of 75, by which time all contracts must be crystallized either by way of full annuity purchase or alternatively secured pension.

Investment Strategy

The segments not encashed remain invested in your pension fund(s). Future investment returns will therefore be critical to the value of further pensions purchased. The most beneficial way to plan for an investment of this type is to establish the time-scales over which income is required - separate pension dates can then be set for various parts of the arrangement. The investment strategy can then be set according to these dates.

What happens if you die prior to age 75?

The benefits available to your nominated survivor will depend on how much of your pension fund remains invested. The treatment of the annuity element is described earlier, in the annuity section. However, in respect of the remaining invested fund it can either be paid as a lump sum, used to purchase an annuity or used for income withdrawals (see later). The options post 75 depends on the type of benefits selected. Full details can be found below.

Advantages

As part of the fund can be taken as tax-free cash, only the annuity derived from the remaining fund is subject to income tax.
Segments remaining invested continue to benefit from the tax efficient environment of your pension fund.
On death, any benefit payable as a lump sum is normally paid free of both income and inheritance taxes. Please see comments under Unsecured Income for full details.
In respect of each annuity purchased, income is paid at least for life and longer, if relevant features were selected at outset.
A level of income appropriate to your needs can be obtained in a tax efficient manner.
It gives the flexibility to make annuity purchase in stages.
The segments not used for annuity purchase remain invested with the potential for future growth.
Subject to the proviso of fluctuation in annuity rates, deferment of annuity purchase to a greater age would normally mean that a higher annuity is purchased.
The value of death benefits may be more attractive.
You may be able to continue contributions to your pension fund.

Disadvantages

The full tax-free cash lump sum entitlement cannot be taken at one time.
Future investment returns are not guaranteed and the value of the pension fund may fall. This may therefore result in a lower total income than if a full annuity was purchased at outset.
Annuity rates may be lower in the future. As a result, buying a series of annuities under the phased retirement option may result in a lower overall level of income than if purchased in full at outset.

For whom might phased retirement be suitable?

Those with significant levels of pension funds.
Those who have other capital/assets on which to draw and therefore do not need the tax-free cash in one lump sum.
Those who wish to provide the maximum death benefits free of inheritance tax.
Those who are uncertain about their health or that of their dependants.
Those who are prepared to take an ongoing investment risk.
Those who wish to reduce their working hours gradually and ease their way into retirement.

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