Increasingly, retirement is not a one-off event. Many of today’s retirees are gradually moving towards full retirement by reducing hours, going part time, or taking up more flexible consultancy work. The thought of abruptly giving up work entirely can be daunting. A phased retirement – where you gradually reduce your working hours to make time for other things – can help you solve the dilemma of whether to retire or not.
In some cases, it can offer the best of both worlds, retaining the interest and purpose of working life alongside more free time to pursue hobbies and interests while still relatively young and in good health. Many employers now offer phased retirement options and with an aging workforce in the UK this is likely to become commonplace.
If you are considering phased retirement your financial arrangements will need to adapt. Fortunately, with some forward planning and utilising the flexibility of ISAs and pensions this should be possible. Here’s five things to think about when making a phased retirement plan.
How to plan a phased retirement
1. Consider how pensions and ISAs can help bridge the income gap
With the state pension not paid until 66, and with that age set to rise, you may need to supplement your reduced earnings from work commitments. This probably means dipping into savings or investments. Utilising various investment products such as tax-efficient ISAs and personal pensions such as SIPPs over the years can give you lots of flexibility.
With pensions you do have some restrictions, though. You can only take income or lump sums from the age of 55, which is due to rise to 57 for those born on or after 6 April 1973 . But you can start and then stop withdrawals, which is useful to complement potentially lumpy earnings from consultancy or other part time employment. Occupational pensions such as final salary schemes will have their own rules about when and how you can take benefits, so check the specific details.
Pensions are highly tax efficient because of the tax relief you receive when making contributions. For instance, a £1,000 contribution to a pension can only cost £600 to a higher rate taxpayer. However, when you come to take money out there is usually income tax to pay beyond the first 25% of the pot.
For ISAs there is no up-front income tax relief, but like pensions all investment returns are tax free. In addition, all withdrawals are tax free, which can mean mixing and matching withdrawals from ISAs and pensions according to overall levels of income and circumstances can make sense. You can put in up to £20,000 each year into ISAs, the valuable aspect being that you can withdraw anytime. This means it’s possible to use them to fund an early or phased retirement in your early fifties (or earlier!), something that isn’t possible with pensions.
2. Think carefully about tax
If you decide to take an income from your pension plan and continue to receive income from employment or self-employment, both will be subject to tax if your total income is over the income tax personal allowance each year of £12,570. When withdrawing from pensions it’s therefore crucial to consider what rate of tax you’ll be paying and whether income could push you into a higher tax bracket.
Methods to mitigate this including withdrawing primarily from ISA savings and investments or utilising the tax free element of your pension – usually the first 25% of a personal pension – to provide a tax free top up while still in receipt of earned income.
If you are at State Pension age, you’ll also need to think about whether or not to claim it. There is nothing to stop you doing so while still in you work. However, if you’re still earning an income, you may decide you don’t need it yet, and you may pay a higher rate of tax if you do. If this is the case, you can defer claiming your State Pension, which comes with the added benefit of increasing the amount you receive when you do decide to take it.
Is it worth deferring the State Pension?
3. Consider whether you still need to add to your pensions
Phased retirement needs to be carefully planned to ensure it doesn’t leave you disadvantaged in later years. You may need to plan for enough income to last you and your partner well into your nineties. While pensions and retirement have become significantly more flexible over the years, there are rules that might prevent you from making larger ‘catch up’ pension payments after you have started taking benefits.
If you are under 75, up to £60,000 can be added into your personal pensions such as a SIPP each tax year, or the equivalent of your total salary – whichever is lower. However, once you start taking taxable income from a pension plan that remains invested, also known as ‘drawdown’, you trigger the ‘Money Purchase Annual Allowance’, which means the maximum that can be paid in reduces from £60,000 to £10,000 a year. This is important to keep in mind if you still plan to boost your pension pot further before fully retiring.
4. Think about when to access your pension money
The longer you put off taking your pension pot, the longer it stays invested with the potential to grow in a tax-free environment. The same applies to ISAs too. If you can get away with relying on your salary you could be better off when the time comes to give up work completely as your investments will have hopefully benefited from further years of compounding returns.
Age can also make a big difference to the income you’re paid when taking your pension as an annuity, a guaranteed income via from an insurance company. The older you are the higher the annuity rate, plus if your health deteriorates you could secure a higher annual income on medical grounds.
Another factor to consider for those planning to hand down money to their family is inheritance tax (IHT). Pensions are generally not included in your estate for inheritance tax purposes and the funds are usually paid tax free to your beneficiary if you die before 75. After that age benefits taken are taxable as income on the beneficiary. When looking at reducing IHT liability, it’s therefore preferable to prioritise withdrawal from ISAs and other sources rather than pensions.
5. Consider getting professional retirement advice
While everyone is keen to enjoy their retirement as much as possible, it’s important to plan carefully and lay the right foundations. You therefore need to balance your ambitions with a robust financial plan to support your goals.
Reconciling your plans with the resources at your disposal by modelling your potential cash flows from various sources can help you decide whether a phased retirement is viable and give you peace of mind.
Still unsure whether a phased retirement is a good idea? Speak to us about planning your retirement and ensure you have enough money for the lifestyle you want.
Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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