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Phased Income Drawdown

An overview of what strategy to take when contemplating phased retirement and the best way to stagger pension drawdown

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By Pete Mugleston  | Mortgage Advisor Pete has been a mortgage advisor for over 10 years, and is regularly cited in both trade and national press.

Updated: 8th July 2019 *

We receive a large number of enquiries from people who are considering winding down their work commitments and looking for guidance as to what to do with their pension to see whether a phased drawdown strategy is possible.

The short answer to this question is yes. Income drawdown can be a feasible option for anyone with a phased retirement plan whereby you still intend to work in some capacity and use a pension fund to plug any gaps in your income.

In this article we will cover:

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What is phased income drawdown and how does it work?

Phased income drawdown is available to anyone aged 55 or over who has, through their working life, paid money into any form of defined contribution pension scheme (also referred to as a money purchase scheme).

Since April 2015, the use of income drawdown has become much more attractive due to a number of changes instigated by the UK government, making these types of policies much more flexible in terms of accessing your pension fund and a healthy alternative to the more traditional method of purchasing an annuity.

Phased retirement and income drawdown

It’s not unusual these days for many people to phase their retirement rather than let it all happen once they reach a certain age. If you decide to cut down the number of working hours you’re prepared to do, this will obviously result in a reduced income.

For example, your reduced working hours mean your monthly earnings have decreased  from £2,500 to £2,000 - how are you going to fill this void? This is where a phased pension drawdown plan can help.

Here’s how it works

By combining your pension drawdown with your phased retirement, you can start to take an income from part of your pension fund which would include the tax-free cash element only for that segment you draw down, leaving the rest of the fund intact.

If you need to increase the income from your pension fund, as you cut back on more working commitments, you can increase the amount you withdraw from the pension fund, which will mean a larger slice of tax-free cash can be included.

Whenever you take out a segment from your fund as part of a phased income drawdown, you can first take part of that portions tax-free element (25% of that segment).

By converting segments of your pension fund on a regular basis, rather than all at once, you are able to stagger the tax-free cash element you receive. The obvious drawback to this is the amount of tax-free cash you can take when you convert the entire fund upon full retirement will not be as high.

Phased income drawdown is a very tax efficient way of allowing you to retire gradually by reducing your working hours and using your pension fund to top up your income until you decide to retire completely.

Why you should speak to an expert if you’re considering phased income drawdown

Retirement planning can be quite complex, which is why its very important you seek independent advice from an experienced advisor before making any major decisions.

The advisors we work with will be able to help you identify pension providers who will offer phased income drawdown plans. Make an enquiry today and we can arrange for one of the pensions specialists we work with to get in touch and discuss further with you.

An example of how phased income drawdown works

To illustrate how this works, we can use the salary example above. If your salary has reduced by £500 per month (£6,000 per annum), you may wish to make up the difference with an equivalent amount from your pension fund.

Let’s say your Independent Financial Advisor (IFA) - by using their phased income drawdown calculator - has recommended you drawdown £12,000 from your fund. From this amount you can take 25% tax-free (£3,000) with the remaining money invested in your drawdown account to provide the remaining income shortfall.

£3,000 equates to £250 per month over 12 months, therefore, 50% of the income shortfall you need now consists of tax-free cash with the other 50% made up from the remaining drawdown funds. The overall effect of this is to reduce the tax burden on your income by £50 each month* as only £2,250 is now subject to tax.

If you continue to work beyond this year, your IFA will be able to advise on what level of phased income drawdown would be needed to plug the gap in your income for future years.

Where can I find a phased income drawdown calculator?

You can find them on a number of pensions websites and finance hubs, including the government’s PensionWise service here - but keep in mind that these online tools will only give you a rough idea of the amount available to you.

The advisors we work with will be able to provide you with more accurate  examples relating to your own circumstances. Call us on 0808 189 2301 or make an enquiry here to get started.

(*Based on the tax band rates at the time of writing)

The advantages and disadvantages of phased income drawdown

Like most pension products, a phased income drawdown may be more beneficial to some than it would be for others. We’ve listed the advantages and disadvantages below to help you make an informed decision, but for more accurate advice relating to your circumstances, speak to an expert.

The advantages:

  • The tax-free cash element of each segment you drawdown can reduce your overall income tax liability
  • You can still take a tax-free cash sum from the remaining pension fund
  • The balance of your pension fund can continue to accrue investment growth
  • You can preserve your pension fund for use in the future when annuity rates may be higher (as you get older), therefore providing a higher regular income when needed
  • If you die before the age of 75, the remaining funds can be passed on to a beneficiary free from any income tax

The disadvantages:

  • Future investment growth is not guaranteed and your pension fund value can decrease as well as increase
  • Your overall tax-free cash sum will be lower when you finally crystallise the remaining pension fund
  • Higher annuity rates (if that is what you decide to do with the funds in the future) are not guaranteed
  • If you die after reaching 75 years of age, any money from the pension fund is added to the beneficiaries income and will be taxed at their marginal rate
  • Phased income drawdown is quite a complex area and regular reviews may incur additional costs

If you’re concerned about any of the potential charges or drawbacks we’ve flagged up here, don’t panic. There’s a chance some, or maybe even all of them, won’t apply to you. But if you make an enquiry, one of the pensions advisors we work with can guide you through phased income drawdown and guide you around any pitfalls.

Speak to a pensions expert about phased income drawdown

If you have questions and want to speak to an expert for the right advice, call Online Mortgage Advisor today on 0808 189 2301 or make an enquiry here.

The pensions experts we work with have access to the whole market, meaning that they’re able to source the best deals that aren’t typically visible to the public. They will also be able to offer free, no-obligation advice for your personal circumstances.

Updated: 8th July 2019
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FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.

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