In years gone by, retirement meant stepping back from the world of work entirely. Traditionally, you'd finish work on a Friday and wakeup the following Monday morning as officially retired.
Today, an increasing number of people are choosing to continue work in some capacity even after they've officially “retired”.
In fact, according to research from abdrn, 66% of those planning to retire in 2022 intend to continue working in some form – up from 56% in 2021, and only 34% in 2020.
One reason “phased retirement” – sometimes also referred toas “flexi-retirement” – may be growing in popularity is because of the rising cost of living. While there are obvious financial benefits of continuing to work, a gradual approach also allows you greater control over the lifestyle and emotional shift from work to retirement.
There are multiple reasons you may want to consider phased retirement. So, if the idea of easing your way into retirement appeals, here are a few pros and cons you should consider.
5 financial benefits of phased retirement
1. Your pension could last longer or provide more income
In the UK, Pension Freedoms legislation allows you to flexibly access your pension savings from age 55. Depending on your life style goals, instead of buying an annuity to provide a regular income, you can vary how much and when you draw money from your pension.
Since phasing your retirement allows you to continue earning an income, it will probably also mean that you’ll need to take less money from your pension.
This offers two advantages. First, since more of your savings will remain invested, you should enjoy more potential compound growth. And second, when you fully retire, you might have managed to save more money. If so, this could provide a higher income and a better quality of life since your pension won’t need to support you for as long.
Continuing to work for longer may also mean you decide to defer taking your State Pension. This can be financially beneficial. For every nine weeks you defer, the State Pension amount increases by 1% – or just under5.8% for every 52 weeks you wait to claim it.
While you can defer your State Pension for as long as you want, whether it is in your best interests will depend on your individual circumstances.
Get in touch to find out whether deferring your State Pension is a sensible option for you.
2. Your pension savings can benefit from better growth potential
Retaining your retirement savings and keeping funds invested while you’re still working can help your pension benefit from more growth.
It’s worth remembering that many pension providers adapt the way funds are invested as you get closer to your retirement date. This is called pension “life styling” and is intended to help reduce the risk of any steep drop in value of your savings if the market falls.
Following a pension life styling strategy, your pension provider moves funds from higher risk investments – those that provide greater potential growth – to lower risk investments, which can reduce the potential returns.
Delaying your full retirement while you continue to earn may mean you find it more comfortable to leave your pension invested in higher risk investments and enjoy greater growth potential.
If you’re thinking of keeping your pension savings invested in higher risk funds, speak to a professional financial planner to ensure you fully understand the implications of your decision.
3. You can keep contributing to your pension
While you continue working and earning an income, you can continue to contribute towards your pension. Of course, if you’re a member of your workplace pension, you can also keep benefiting from employer contributions.
If you draw from your pension, your contributions may not benefit from the same tax relief that you have been used to. Read more about this below, where we discuss the potential drawbacks of a phased retirement.
4. You could buy an annuity at a time that better suits you
Your annuity sets an income for life and its value is determined at the time you buy. When you use your pension to buy an annuity, the decision cannot be reversed.
Phased retirement can, where necessary, allow you to draw a small income from your pension while you work. This may allow you the option to buy an annuity later in life when you want the security of a guaranteed income.
This allows you the luxury of time to decide when to lock yourself into an annuity. Delaying when you buy an annuity could also mean that the resulting income is more generous.
5. You can use the time to become accustomed to your new lifestyle and expenditure
Having helped many people around the world successfully plan for their retirement, one challenge we often see people struggle with is understanding the amount of income they’ll need when they stop work.
One of the benefits of easing your way into retirement is that you can use the time to get used to your changing spending pattern. As you approach full retirement, you can often get a better feel for how much your pension will need to provide.
The slower transition to retired life can give you much-needed time to become accustomed to the inevitable change of pace, too.
2 potential drawbacks of taking a phased retirement
1. You could end up paying unnecessary Income Tax
If you're working and making pension withdrawals, you'll need to manage things with care to avoid paying unnecessary Income Tax.
Where possible, try and spread your withdrawals throughout the year, and over several tax years, to benefit from your tax-free allowances.
It may be useful to avoid unnecessary or large one-off withdrawals since, combined with your earned income, these could more easily push you into a higher Income Tax bracket.
If you have built up tax-efficient savings alongside your pension (in ISAs, for example), it's often a good idea to draw income from these before drawing from your pension. Any money withdrawn from ISAs is typically free of both Income Tax and Capital Gains Tax.
One benefit of using money from ISAs and other investments ahead of your pension is that pensions don’t typically form part of your estate when you die.
Depleting your other savings first could mean you reduce a potential Inheritance Tax (IHT) liability on your estate.
2. You may risk falling foul of the “pension dipper tax trap”
Because of the Money Purchase Annual Allowance (MPAA) rules, if you start drawing money from your defined contribution (DC) pension fund, the amount you can contribute to your pension while still enjoying tax relief might be reduced.
To benefit from pension tax relief, most people can contribute up to £40,000 or 100% of their annual earnings, whichever is lower. This sum includes any employer contributions.
However, if you trigger the MPAA, this reduces to just£4,000 a year.
Triggering the MPAA could lead to an unexpected bill. If you had planned to contribute more than the £4,000 to your pension, this may have a negative impact on your long-term retirement plans.
Generally, the MPAA won’t be triggered if:
- You only access your tax-free lump sum, usually25%
- You buy an annuity
- You move your pension into a flexi-accessdrawdown scheme but don’t withdraw an income
- Your pension is valued at less than £10,000.
The MPAA rules can be complex. If you’re unsure if your plans may trigger the MPAA, please get in touch.
Get in touch
If you’d like to find out if phased retirement would work for you, please get in touch.
Email us at enquiries@alexanderpeter.comor give us a call on +44 1689 493455.
Please note
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.
