5. Phased Retirement & Unsecured Income (Phased Drawdown)

How does it work?

This option combines phased retirement and unsecured income. You may set up a phased retirement arrangement but, instead of using the segments encashed to purchase an annuity, they can be used for income withdrawals. This gives control over the continuing investments as well as the ability to defer annuity purchase.

By only phasing in the part of the pension fund you need, and not being restricted to buying a fixed annuity, you can, if you so wish, defer buying all annuities. You can build up your income as and when you wish, with the added flexibility of varying the income between certain limits.

With the continued investment in a tax-efficient environment and the ability to take a series of tax-free cash lump sums as part of your income, this option offers you the maximum flexibility for tax planning purposes.

Investment Strategy & Management

The value of the fund, the income you withdraw each year and the final pension you purchase will all be dependent upon the careful management of the funds remaining invested. It is therefore essential that a good investment strategy be adopted when starting this type of plan. Where a combination of phased retirement and unsecured income is entered into, this makes the investment process particularly complex as it will require a combination of the two strategies, as referred to in the previous sections.

What happens if you die prior to age 75?

The benefits available to your nominated survivor depend on how much of your pension fund remains invested. In respect of the segments not yet encashed for unsecured income, the value of the fund can either be paid as a lump sum, used to purchase an annuity or used for income withdrawals.

In respect of the fund already being used for unsecured income, there are generally several options available:

Receive a cash lump sum, subject to a tax charge of 35%.
Purchase an annuity.
Continue taking withdrawals until either he/she reaches age 75 or you would have reached 75, whichever is the earlier. At age 75 withdrawals can continue via an alternatively secured pension
(If your spouse is under 60 when you die) leave the value of the fund in the plan and defer purchasing an annuity up until his/her 60th birthday. It is not possible to take income withdrawals once this option has been selected.

Taxation Issues

As part of the income can be taken as tax-free cash, only the part used for income withdrawal is subject to income tax.
Funds remaining invested continue to benefit from the tax efficient environment of your pension fund.
If, on death, the remaining fund opened for PFW is paid as a lump sum, a tax charge of 35% is applied.
Generally, any lump sum will be paid free of inheritance tax but in certain situations, HM Revenue & Customs may apply such a tax. Please see comments under “Unsecured Income” for full details.

Advantages

The combination option gives you a high degree of control over your tax planning.
It gives the flexibility to defer annuity purchase.
It gives the flexibility to take income withdrawals in stages.
A level of income appropriate to your needs can be obtained in a tax efficient manner.
Both the funds being used for Unsecured Income and the balance not yet encashed remain invested. You therefore retain control of your investment with the potential for future growth.
Income may be varied, up to a certain limit, to suit your personal circumstances.
Flexibility in income levels may provide scope to mitigate your personal liability to income tax in certain years.
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 an annuity was purchased at outset.
Annuity rates may be lower in the future. As a result, the eventual annuity may be lower than the annuity that would have been available at outset.
High withdrawals of income may not be sustainable during the income withdrawal period and may also reduce the amount of any potential annuity.
The higher the level of income withdrawal chosen, the less that may be available to provide for dependants, particularly when the original fund is small and/or investment returns are poor.
Increased flexibility brings increased administration costs. Charges are likely to be higher than those relating to annuity purchase and may increase in the future.
It is possible that the level of income selected at outset may need to be decreased or increased to comply with new limits arising from a quinquennial review.

For whom might Phased Drawdown be suitable?

Those who have significant levels of pension funds.
Those for whom careful tax planning and therefore maximum flexibility is required.
Those who wish to defer annuity purchase.
Those who wish to maintain control over all the remaining investments.
Those who do not need the maximum tax-free lump sum in one go, particularly where there are significant levels of non-pension assets/capital to draw on.
Those who can afford to postpone taking withdrawals in periods of adverse investment conditions.
Those prepared to take a significant investment risk, as the entire pension fund will remain invested.

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