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Phased Retirement


Important 2015 Update

While the information below still remains valid, a lot of the functionality of Phased Retirement arrangements have effectively been superceeded by the introduction of Flexi-Access Drawdown Pensions. These perhaps offer ever greater flexibility than Phased Retirement contracts, although existing Phased Retirement plans that are in place can continue to operate as before.


Phased retirement allows you the flexibility to take benefits from personal pension funds in stages, leaving the balance of funds invested. There may be a number of reasons for doing so. For example, you may wish to ease into retirement and work shorter hours. This option would allow you take a low level of income initially, and increase it later as you spend less time at work. It may be possible, depending on how your plan is set up, to continue to make contributions, subject to the new overall lifetime limit.
Your pension fund is split into a number of equal segments (typically 1,000) and this allows you to use just some of the segments to buy your pension, leaving the remainder invested until required. The segments can be encashed for annuity purchase indefinitely. You determine how much of your income is required for the first year and the pension company calculates what proportion of the fund is required to provide this level of income (i.e. how many segments need to be encashed). When you take income by encashing segments you have the option to take up to 25% of the value asa tax-free lump-sum and the balance is used to buy an annuity. In subsequent years, you will continue to receive income from the annuity or annuities purchased. If additional income is required further segments from the pension fund can be encashed, again using up to 25% of the value as tax-free lump-sum. This process may continue indefinitely until all the segments have been encashed.

Investment Strategy

The segments not encashed remain invested in your pension fund(s). Future investment returns will therefore be critical to the value of further pensions purchased. The most beneficial way to plan for an investment of this type is to establish the time-scales over which income is required - separate pension dates can then be set for various parts of the arrangement. The investment strategy can then be set according to these dates.

What happens if you die?

The benefits available to your nominated survivor will depend on how much of your pension fund remains invested. The treatment of the annuity element is referred to in the annuity section. However, in respect of the remaining invested fund it can either be paid as a lump sum, used to purchase an annuity or used for Drawdown Pension.

Taxation issues

  • As part of the fund can be taken as a tax-free lump-sum, only the income generated from an annuity or pension fund withdrawal is subject to income tax.
  • Segments remaining invested continue to benefit from the tax efficient environment of your pension fund.
  • On death, any the unencashed segments can be taken as a lump sum, and are paid free of both Income and Inheritance Taxes.

Advantages of Phased Retirement

  • In respect of each annuity purchased, income is paid at least for life and longer, if relevant features were selected at outset.
  • A level of income appropriate to your needs can be obtained in a tax efficient manner.
  • It gives the flexibility to make annuity purchase in stages.
  • The segments not used for annuity purchase remain invested with the potential for future growth.
  • Subject to the proviso of fluctuation in annuity rates, deferment of annuity purchase to a greater age would normally mean that a higher annuity is purchased.
  • The value of death benefits may be more attractive than annuity purchase or pension fund withdrawal.
  • You may be able to continue contributions to your pension fund.

Disadvantages of Phased Retirement

  • The full tax-free cash lump sum entitlement cannot be taken at one time.
  • Future investment returns are not guaranteed and the value of the pension fund may fall. This may therefore result in a lower total income than if a full annuity was purchased at outset.
  • Annuity rates may be lower in the future. As a result, buying a series of annuities under the phased retirement option may result in a lower overall level of income than if purchased in full at outset.

Why might phased retirement be a suitable option ?

  • You have significant levels of pension funds.
  • You have other capital/assets on which to draw and therefore do not need the tax free cash in one lump sum.
  • You wish to provide the maximum death benefits free from potential inheritance tax liabilities.
  • You are prepared to take an ongoing investment risk with your pension funds.
The options outlined have in some degree been affected by the proposed changes in pension legislation that took effect after 6 April 2006. Please refer to the pension simplification document for more details and clarification.
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.

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