PHASED RETIREMENT

You do not have to use your entire pension fund at once and can use just part of it to provide benefits, either by moving into pension drawdown, or by buying an annuity, or both. This is called phased, or partial, retirement.

Each time you move money into your pension drawdown account it will count as a Benefit Crystallisation Event (BCE) and could trigger an immediate review and adjustment of the maximum income you can take from the whole of your pension drawdown funds. This could mean you have to reduce the income you take. This is in addition to the automatic tri-annual that are carried out. If the reduced maximum income would be less than the income already taken then it won’t be possible to move any more money into drawdown until the following year.

Phased retirement is more likely to be chosen by those who do not need all of their tax-free cash in one go and would prefer to keep more money invested in a tax efficient manner until they need it. There are also implications regarding death benefits, as it would be possible to have some money from which you have not yet taken benefits, some in an annuity and some in pension drawdown. The death benefits in these three cases are all treated differently.  The older you are, the more competitive an annuity income becomes.

If you die and leave any pension funds that have not yet been used to buy an annuity, or transferred into drawdown, they can be paid out as a lump sum, which is normally free of inheritance tax (a death tax charge of 55% will apply to un-crystallised funds post age 75 years). Alternatively a spouse or dependant can choose to use the full fund value to buy an annuity or start pension income drawdown.  However please note that contracted out pensions require that an income is made available for a surviving spouse or civil partner. This can be either via an annuity or income drawdown. Only where there is no spouse or civil partner may the fund be passed to another nominated beneficiary.

The fund will be valued against the “lifetime allowance” which for most people is currently £1.8milion as of the 2010/11 tax year.  This will decrease to £1.5 million in 2012/13.   If your total pension funds and benefits on death (including any pension life insurance) exceed the lifetime allowance the excess over this could be subject to a lifetime allowance charge of up to 55%. The lifetime allowance charge should not apply where funds are used to provide a dependant’s income.

Phased retirement is a personal pension plan which accepts existing funds and allows you to buy an annuity or income drawdown in stages rather than all at once. Each year you decide how much income you need. You then cash in as much of the plan as necessary to provide your chosen level of income. Please note that the value of the remaining fund can go down as well as up and is not guaranteed, and that annuity rates can vary over time. So you could end up with a lower pension than if you'd chosen a conventional annuity straight away. You can take out a phased retirement plan any time after the age of 55.

Think of it as lots of mini-retirements spread out over a number of years. At first your income will consist of a tax-free cash sum and income from either an annuity or a pension Income Drawdown plan. You'll continue to receive income from these sources, but you also have the option to take another tax cash-free sum and set up further Income Drawdown plans or annuities. 

Phased retirement can work like this:

• Income drawdown plus tax-free cash - to a maximum of 25% of the value of the 'arrangements' you're cashing in.
• Annuity plus tax-free cash - to a maximum of 25% of the value of the arrangements (please ask your financial adviser for more detail).
• Meanwhile, the 'arrangements' left in your plan, called 'deferred arrangements' continue to be invested.

Phased Income Drawdown or Phased Annuities?

This depends on your circumstances and attitude to risk. Pension drawdown provides greater flexibility and a higher potential income, but annuities, being guaranteed, give greater security. You should talk to your financial adviser about what might suit you best.

Phased retirement is a relatively complex arrangement so charges are higher than if you'd chosen the traditional annuity route.

Who could it be suitable for?

Phased retirement can be taken out by people aged over 55 years. It could be just the thing for you if:

1. You want to vary your income from year to year to reflect changes in your circumstances.
2. You want your pension fund to continue to benefit from potential growth and are prepared to accept the risk that its value may fall rather than rise and is not guaranteed.
3. You have other sources of income so you may not need a high income in the early years of retirement.
4. You want to attempt to maximise the benefits your family receive on your death and give them maximum choice about how they receive these benefits.

 Phased Retirement – Advantages & Disadvantages

 Advantages

• The pension fund not encashed remains in the Phased Retirement plan and continues to be invested thus providing the individual with the possibility of growth and hence, higher future income.  This depends largely on how much income is taken out of the fund (especially in the early years) and future investment returns achieved on the residual pension funds.

• The individual can change the level of their retirement income to reflect their personal circumstances in the future, although if a pension annuity is purchased, this income payment will continue for the rest of their life.

• By delaying the purchase of a pension annuity, the individual is more likely, due to age to suffer form an illness which means they could qualify for enhanced or impaired annuity rates, thus increasing their pension income for the rest of their life.

• The portion of the pension fund still invested at the time of the annuitant’s death can normally be returned to the individual’s beneficiaries free of Inheritance Tax.

Disadvantages

• Your income is not guaranteed - it depends on several factors including the level of pension income drawdown, investment returns you achieve, the effect of the charges, and future annuity rates. Your investments may not perform as well as you had anticipated and annuity rates may go down. There is no guarantee you will get more than had you bought a conventional annuity straight away, and you could get less.

• You can't take your tax-free lump sum in one go. And as you will be using your tax free cash to provide income along the way, you may only have a small amount left to take when you convert the remaining value of your plan into an annuity.

• If you are using pension drawdown to phase your retirement, the withdrawals you make to provide an income reduce your remaining fund and may erode the capital value of the remaining retirement fund below that originally invested, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased or an amount less than you would have received under an existing arrangement. It is possible for the capital value of the plan to fall below the amount of the initial investment.

• Annuity rates vary over time. If you leave it until the last moment to convert your remaining fund into an annuity, you will be forced to accept the rates available at the time. They may not improve and may worsen.

• The charges you pay for phased retirement will be higher than for a conventional annuity.

• The Protected Rights benefits are your entitlement from the State Second Pension, previously the State Earnings Related Pension Scheme (SERPS). You cannot phase these benefits. However you can invest the money separately within the plan. Up to 25% of the Protected Rights fund can be taken as tax-free cash.