Phased Retirement
Overview
Phased retirement allows you to control your retirement fund
and convert it gradually over a number of years into income.
This control is achieved by setting up many contracts (often
more than 1,000) and using a number of them each year to
provide you with your desired level of income. This income
will be made up of part tax-free cash and part annuity. The
annuity provides ongoing fixed income for life.
The balance of your pension fund (i.e. the contracts not
cashed in or ‘vested’ to provide you with a given level of
income) continue to be invested, thus providing you with the
possibility of higher future income. This will depend mainly
on how much income you take out of the pension fund
(especially in the early years) and future investment
returns.
Tax Free Cash
Immediate maximum tax-free cash is not available since it is
used each year to provide part of your income.
Income
Because the income is made up of annuity payments and a
portion of tax-free cash, your overall liability to Income
Tax is reduced. Payments are taxed in the same way as a
‘Lifetime Annuity and can be made monthly, quarterly, half
yearly or yearly, in advance or arrears. Additionally, the
payments can remain level or can increase in payment.
Death Benefits
The option of what type of death benefits to include is made
at outset for the annuity purchases. The residual fund (i.e.
units not vested) can be paid, on death, as a lump sum to
your nominated beneficiary.
Advantages
● You retain investment control
of the segments of your pension fund not yet used to
purchase an annuity.
● As you get older there is the
prospect of annuity rates rising and providing you with
higher income. It is cheaper for insurance companies to
purchase an annuity to provide a given level of income for
someone age 70 than for someone age 60 (assuming the returns
provided by medium to long-term gilt yields remain the
same).
● You will be able to change the
shape of your retirement income to reflect your personal
circumstances in the future, although once you have
purchased an annuity, this income payment will continue
unchanged for the rest of your life. Each year an annuity is
purchased you can chose whether to include death benefits
and other options.
● An annuity must be purchased
at age 75 at the latest with the whole of the pension fund
or the unvested funds could be used to purchase an
Alternatively Secured Pension (ASP).
● The remaining pension fund
(i.e. the policies not cashed in or ‘vested’) can be
returned to your beneficiaries free of Inheritance Tax on
your death before age 75.
Disadvantages
● There is no guarantee that
your income will be as high as that offered under the
lifetime annuity route referred to earlier.
● You must still purchase an
annuity to provide income whenever you draw part of your
tax-free cash. Of course, annuity rates at that time may not
be favourable.
● Deferring the purchase of the
annuity does not guarantee a higher level of future 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.
● The value of your remaining
pension fund, when aggregated with any annuity you have
purchased, may not achieve an equivalent level of income to
that which could have been purchased with the whole fund at
outset via a Lifetime Annuity. This is because withdrawals
of tax-free cash and annuities purchased will erode the
value of your pension fund if investment returns are not
sufficient to make up the balance (including charges for the
ongoing administration of the plan).
● 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.
● You may not receive all of
your tax-free cash as a lump sum at outset, because you are
using this cash to supplement your income.
Suitability
Phased Retirement is most likely to suit individuals who
want to gradually retire, i.e. self-employed, or those
individuals who are likely to be higher rate taxpayers. They
also suit individuals with a medium or higher attitude to
risk and security because there is an element of risk
involved due to the balance of the pension fund remaining
invested.