Phased Retirement

What is Phased Retirement?

An individual may wish to phase his retirement. This is very useful for a self-employed person gradually running down his workload towards retirement, or someone moving from being a full-time employee to a part-time consultant. Rather than switching on all pension funds at once, phased retirement involves drawing down benefits sequentially from retirement funds.

How does Phased Retirement work?

At its simplest level, a client may have a number of different contracts and take the benefits from these contracts at different times. The contracts may be with the same provider or with different providers e.g. to spread investment risk. A pension could be taken from one of the contracts to provide for current income needs, simply using the tax free cash from that contract to supplement income, leaving the other contracts in force to gain the benefits of tax free growth for as long as possible. Alternatively a single life office may be preferred, using a plan consisting of say, one thousand segments designed especially for staggered vesting. In the first year of vesting, the required level of income and enough segments are vested so that the total of the 25% tax free lump sum and the first years net pension equals the target income. This process is continued annually thereafter. There is nothing to prevent the phased retirement approach being combined with income drawdown, i.e. instead of buying an annuity with the vested segments, drawdown is started. The result is increased flexibility, albeit with considerable administrative complexity.

Who is Phased Retirement Suitable for?

These arrangements are probably most suited to investors who have no need for a large lump sum at retirement which can then be gradually drawn down and be used as income. As noted previously, it is particularly suited to clients who wish to gradually reduce their income from work, turning on pension funds gradually to supplement their income. Clients must be aware that annuity rates are not guaranteed and maybe higher or lower at the vesting dates than on a conventional single vesting annuity contract and that there are investment risks moving into retirement as well. As the unvested portion of the pension funds may be held outside the client’s estate, phased retirement maybe particularly suitable for a client who needs an element of retirement income, but wishes to leave as much of their fund as possible to pass to beneficiaries free of Inheritance Tax.

Risk warnings

• Future annuity rates are not guaranteed; they can and will fluctuate on a daily basis, down as well as up. This is because they are dependent upon economic conditions and are frequently changed.
• High-income withdrawals may not be sustainable, 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. This is especially so where investment returns are poor. This can result in a lower income once an annuity is eventually purchased.
• The investment returns may be less than those shown in the illustrations.
• If there is prima facie evidence that a client in ill health elects not to take benefits at the specified age in order to increase the estate of someone else, the Capital Taxes Office may consider the failure to take retirement benefits gives rise to a charge to IHT. For death within Drawdown, rather than ASP, this is unlikely to be pursued where the investor survived for two years or the death benefit was paid to a spouse and/or dependent.
• Due to fluctuating value of the funds actually paid to purchase your pension, your future annuity could be greater or smaller than the values used in this report. There is no guarantee that annuity rates will improve during the drawdown period of deferral: indeed, they may deteriorate.
• The funds that remain invested in the pension plan could leave you open to investment risk during the drawdown period.
• Past performance of investment funds is not necessarily a guide to future returns.
• There are no guarantees that your income will be greater than if you used your entire fund to purchase a pension immediately. If annuity rates fall, or investment growth is poor, your retirement income could be lower.
• With annuities, those who die prematurely effectively subsidise those who live longer. Where you defer buying an annuity – as you will both be doing by effecting drawdown arrangements – the benefit of this cross-subsidy is reduced. This is known as "mortality drag" and increases the yield your drawdown funds must achieve in order to match what the value of the retirement benefits you could get through buying annuities.