As we've seen, you don't have to leap straight from full-time work into retirement; you can phase the process. So, what might that mean for your pensions?
How Phased Retirement Works with Your Pensions
I think we’re all fairly comfortable with the idea that it might make sense for some people to ease into retirement, for both physical and financial reasons. But what does it look like from a pension management point of view?
As I said in the last post, the phrase ‘Phased Retirement' is a technical term, specific to the process of shifting money into drawdown over time. Let’s go over this carefully. Most folks reading, I think, will be comfortable with the idea of drawdown.
This came about as a reaction to the once-for-all nature of the alternative, which was annuity purchase. With an annuity, you hand over your accumulated pension to a life insurance company in a once-for-all, irreversible transaction, and in return they give you a guaranteed income for life. That sounds OK, but the big question is the exact nature of ‘for life’ – none of us knows how long we’re going to live!
So, necessity being the mother of invention, drawdown was invented in 1995 to provide an alternative. Essentially it allows you to keep your pension fund invested and if you think of it as a bucket with your money in it, you can stick a tap on it so you can draw money off your pension fund as you need it.
It used to be that the amount you were allowed to draw from a drawdown plan was capped using something called the Government Actuary’s Department or GAD rate, but that’s all history now since Chancellor George Osborne removed all that and ushered in the age of flexible pensions in 2015. Phased drawdown was the process of shifting only part of your pension fund into drawdown, leaving the rest ’uncrystallised’.
Here’s an example. Let’s say you have no earned income at all. You’ve finished work and are volunteering. You have zero income whatsoever, no rent from buy-to-lets, no state pension, nothing. You have a personal allowance for income tax which is being unused, and let’s face it, you’ve gotta eat so you need money from somewhere.
So, you decide to phase some of your pension fund, and it doesn’t matter how big that is. You decide to phase £16,666 of it, even though the personal allowance is, as I write this, £12,500. Why might that be?Well remember that one quarter of anything you take from a pension can be taken as tax free cash.
In this example, one quarter is £4,166 and the balance is £12,500. So you get £16,666 out of your pension without paying any tax by using both your tax-free cash and your personal income tax allowance – marvellous! The ‘taxable’ bit falls fully inside your personal allowance.
It used to be more complex than that when the amount you could draw down was capped, but it isn’t any more, so it’s easier! In this example, anything you hadn’t taken from the pension stays uncrystallised, with all the benefits of that – outside your estate for inheritance tax, easily and tax-efficiently passed to your beneficiaries, all that good stuff.
Worth mentioning a similar arrangement called UFPLS, which stands for Uncrystallised Pension Fund Lump Sum. In the first example, and in true drawdown, you have two accounts, one crystallised and one uncrystallised.
The process is that you decide how much to crystallise, then that money moves across to the drawdown account, and then gets paid out to you either all in one go or over time. UFPLS misses out the middle step and so a drawdown account is unnecessary.
That can be useful if your pension plan charges annual fees for running a drawdown account. With UFPLS, the money comes straight out of the uncrystallised pot and into your bank, but is otherwise treated in exactly the same way.
OK? Good! Let's move on.
Leave a Reply