Retiring Gradually; The Options

Not ready to retire fully, your options are...

Most personal pensions can be arranged not as a single plan, but as a cluster of many separate plans, sometimes called `segments'. The segments can then be used to buy annuities at different times. All the segments must be used to buy annuities by the time you reach the age of 75. This process is called 'phased retirement'.

Phased retirement is complicated and requires thought, planning and management. You'll probably need some specialist financial advice.
Each time you convert a segment to an annuity, you can first take part of the segment's fund as tax-free cash. Converting segments regularly, for example, once a year, means you can effectively use the tax-free cash, as well as the annuity, to provide your income. The drawback is that if you stagger the conversion of segments into annuities, you will not be able to take all your tax-free cash from your total pension fund at once as a single lump sum.

You must convert enough segments each time to buy an annuity. Insurance companies often set a minimum purchase price.

Phased retirement can be a very useful financial planning tool, for example, if you want to ease back gradually on work and start to replace your earnings with pension income.

It may also be more flexible for your survivors if you die; Segments that have not yet been converted to annuities can provide a pension for your surviving dependants or a lump sum, depending on the terms of the pension plan.

Phased retirement is generally suitable only if you have a fairly large pension fund, or have other assets or income to live on. This is because the bulk of your pension savings remain invested ¬ usually in the stockmarket ¬ which may be more risky than buying an annuity straight away.

'Unsecured Pension - an alternative to buying an annuity –
until age 75 at the latest`

You do not have to buy an annuity straight away when you want to start taking an income from your pension fund.

Instead, you can put off buying the annuity as late as age 75, though it is a good idea to review this decision regularly. In the meantime, you can take an income direct from your pension fund - this is called `unsecured pension' or `income drawdown'.

If you want to take part of your pension fund as a tax-free lump sum, you do this before starting to take income from the fund. The income you take out of your remaining pension fund is taxable.

Unsecured Pension is an option with some personal pensions and some types of employer's scheme. But sometimes, if you are in an employer's scheme and want to use income withdrawal, you must first transfer your pension rights from the employer's scheme to a personal pension. There will probably be charges for making this transfer.

Income withdrawal involves extra costs and extra investment risk compared with buying an annuity straight away. For this reason, it is usually suitable only if you have a pension fund of over £150,000 (after taking tax free cash) or you have other assets and sources of income to fall back on.

Because the bulk of your savings remain invested in the stockmarket, the value of your pension fund can go down as well as up.

Provided you understand these risks and feel comfortable with them, there are several reasons for considering income drawdown:

• you want the flexibility to vary the amount of pension income you take. Maybe you need the cash lump sum but have little immediate need for income. Or perhaps you are retiring gradually and need a flexible and increasing income.
• you want to leave your heirs the bulk of your pension fund (though a tax charge would be deducted) if you died before reaching age 75.
• you are confident that your pension fund can be invested for a better return than you would have got from an annuity. This almost certainly means investing in share-based investments and you must feel comfortable with the stockmarket risk.
• you want to avoid being locked into current annuity rates. But bear in mind that future annuity rates could fall.

The Inland Revenue limits the maximum income that people can take out of their pension fund through income withdrawal. The maximum is broadly the same as a level annuity for a single person of your age and sex. Like annuity rates, this maximum often changes. There is no minimum income.
The company that you invest with must review your income withdrawal arrangement every three years.

This is to make sure that your income stays between the Inland Revenue's minimum and maximum limits. This means you may have to take a cut in income if you had been drawing the maximum or an increased income if you had been drawing the minimum.

Think about reviewing your income every year as well as the decision on when to make the final annuity purchase.

Phased retirement and income withdrawal can be combined

This means you would start to draw an income from just part of your pension fund on one date, leaving the rest of the fund intact. To increase your income at a later date, you could either increase the rate of withdrawal (provided you did not exceed the maximum limit) or start to draw an income from a further slice of your pension fund. This option is very flexible, but complicated. Get professional advice.

If you opt for a high withdrawal rate and investment returns are poor, income withdrawal may run down your pension fund too quickly. There is a danger of running it down so far that, when you eventually have to buy an annuity, you can afford only a very small income for your remaining retirement.

Example of income withdrawal

Dan retires at age 55. He will have £250,000 in his pension fund after taking a tax-free lump. Since annuity rates are relatively low for someone as young as Dan, he is interested in income withdrawal. His financial adviser works out the current limits on the income Dan can take. The maximum is £17,500 a year. These limits will apply for five years, after which they will be recalculated and will probably change.

Contact us today for a free phased retirement consultation