Phased Retirement is another option when taking retirement benefits. The main objective is to provide a greater degree of control and flexibility over your pension fund.
Phased Retirement is a flexible and tax efficient way of providing an income in your retirement. You can control how much income you receive, in what form and how the remaining pension fund is invested.
Retirement funds are combined into one personal pension consisting normally of anything between 100 and 1,000 separate but identical segments, which can be drawn on as required.
You decide on the level of income that you require and the provider calculates the amount needed to provide 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 an Annuity or Drawdown.
The remaining segments remain invested until required.
Yearly reviews are recommended therefore in the second year you decide how much income is required, after taking into account the income already being received from the
Lifetime Annuity or the Income Drawdown arranged in the first year.
In each subsequent year the same process is repeated allowing you to take account of changing personal and family circumstances.
Unlike an 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 need.
If there is no immediate need for the full tax free cash amount, phased Income Drawdown may be a suitable approach.
With phased Income Drawdown a combination of your tax free cash and income is used to provide the required overall income. Using this approach means that only the amount required to provide the overall income needed is vested from your Personal Pension into Income Drawdown and the remainder of the fund stays invested in the personal pension plan.
The benefits of this approach are:
- The ability to maximise death benefits. In the event of death the Personal Pension element is not subject to the 55% tax payable on the Income Drawdown element
- The initially unused tax free cash can be taken out at any time and will benefit from any growth on the personal pension fund
- It keeps more of your funds in a tax efficient environment
- A tax efficient income - it's part tax free cash
- Ideal for who are retiring gradually and who are still working and earning
The benefits paid when you die will normally comprise of two elements:
- Firstly, 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, 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.
- Secondly, 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.
The following are a number of advantages of phased retirement that reflect the benefits of deferring taking pension annuities until later:
- The pension fund that isn’t encashed remains in the phased retirement plan and continues to be invested. This provides you with the possibility of a higher future income. This depends largely on how much income is taken out of the pension fund (especially in the early years) and future investment returns achieved on the residual pension fund.
- You can change the shape of your retirement income to reflect personal circumstances in the future, although once a pension annuity is purchased, this income payment will continue for the rest of your life.
- As you get older there is the prospect of annuity rates rising and providing you with a higher income. This is because it is cheaper to purchase an annuity to provide a given level of income for someone age 70 than someone age 60, assuming the returns provided by medium to long-term gilts remains the same.
This is because life expectancy (years left to live) is expected to be shorter for a 70 year old so less pension fund is required to purchase the same level of income. The expectation is that the insurance company will pay out income for a shorter period of time. The annuity is purchased by cashing in those contracts not previously cashed in or 'vested' to provide benefits in the form of a pension income.
- If your market expectations are that medium to long term interest rates and gilt yields may raise and if this happens you will be able to achieve a higher amount of income, through the purchase of an annuity.
- The remaining pension fund being the policies not cashed in or "vested" can normally be returned to beneficiaries free of Inheritance Tax on death.
The following are a number of disadvantages of phased retirement that reflect the opportunities lost of deferring taking a pension annuity until later:
- There is no guarantee that your income will be as high as that offered under the compulsory purchase annuity or transfer routes referred to earlier.
- The value of your remaining pension fund, when aggregated with any annuity you have purchased, may not achieve the required level of growth to maintain income levels at the same level to those achieved through the purchase of a compulsory purchase annuity. This is because withdrawals of tax free cash and annuities purchased may erode the value of your pension fund, if investment returns are not sufficient to make up the balance.
- Deferring the purchase of the annuity does not guarantee a higher level of 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.
- 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.
Without the need to buy an annuity at the age of 75, you now have more flexibility and choice when you retire. The following table compares capped, phased retirement and a traditional annuity.
|TAX FREE CASH||Y||Used as part of income||Y|
|Income Security||Depends on investment performance and gilt yield||Depends on investment performance||Payments pre-determined|
|Income Variables||Very flexible||Flexible particularly if drawdown used||Very limited|
|Dependents Benefits||Decision can be postponed||Decision can be postponed. Exception when part of fund is used to purchase an annuity||Have to select at outset|
|Capped and Flexible Drawdown option||Yes||Yes excluding annuity purchased||No|
|Death Benefits before age 75||Full value of fund minus a 55% tax charge||Full value of uncrystallised fund||Can apply for 10 year guarantee or capital protection at outset|
|Investment Risk||Yes||Yes||No however inflation may impact fixed benefits|
|Mortality Drag||Yes||Yes but not for funds that purchased an annuity||No|
|Complex||Yes requires regular reviews||Yes requires regular reviews||No unless investment linked|