Retiring from work is a big transition for many people. Your career might be an important part of who you are, and your colleagues may have become close friends.
So, it’s not surprising that retiring gradually – “phased retirement” – is becoming an increasingly popular choice.
Indeed, research published by Aviva has revealed that 40% of 55- to 64-year-olds plan to flexi-retire before they turn 65.
Read on to learn more about phased retirement and discover three key financial factors to consider before you step back from work.
A phased retirement offers flexibility in how you manage the transition from employment to retirement
A phased or “flexi” retirement is where you gradually reduce your working hours as you approach retirement.
If the thought of leaving work behind completely feels daunting, or you’re keen to gain a better work-life balance while continuing to pay into your pension, a phased retirement might be a good option.
Indeed, retiring gradually could give you more free time while also allowing you to enjoy the emotional and financial benefits of working.
Emotional benefits of working
- A sense of routine and purpose.
- Opportunities to socialise and maintain long-held relationships.
- Keeping mentally and physically active.
Financial benefits of working
- Your retirement savings may last longer.
- You’ll receive an ongoing income.
- You can continue making tax-efficient contributions to your pension.
Research reported in the Telegraph has revealed that people who work either full- or part-time enjoy improved mental health than those who have retired.
Also, with people in the UK living longer on average than previous generations, your retirement could last 30 years or more. So, boosting your savings pot by working for longer – even if you reduce your hours – might be a sensible choice.
Key financial considerations for a successful phased retirement
While a flexi-retirement could offer several benefits, it’s crucial that you plan your finances with care.
If you reduce your working hours, this is likely to mean that you’ll receive a lower annual salary than when you worked full-time.
So, to ensure you maintain the income you need for your desired lifestyle during your phased retirement, it’s worth considering the following three points.
1. Plan your pension withdrawals with care
You can usually access a workplace or private pension from the normal minimum pension age of 55 (rising to 57 from 6 April 2028 for most people). So, you might choose to top up your reduced income using your pension savings.
Normally, you can take up to 25% of your pension as a tax-free lump sum when you reach the normal minimum pension age. However, your 25% cannot exceed the Lump Sum Allowance (LSA), which stands at £268,275 (2024/25). This could be higher if you previously had a protected Lifetime Allowance (LTA).
You can then start taking an income or lump sums from your remaining fund.
However, if you start drawing flexibly from your pension savings over the 25% tax-free portion during your phased retirement, you could trigger the Money Purchase Annual Allowance (MPAA). This reduces your Annual Allowance to £10,000 (2024/25).
Normally, you’ll have a pension Annual Allowance of £60,000 (2024/25), or 100% of your earnings, whichever is lower.
This is the maximum amount you can contribute to your pension in a single tax year without facing an additional tax charge. Your Annual Allowance may be lower if your income exceeds certain thresholds.
Of course, you can choose to pay more than your Annual Allowance into your pension, but your contributions won’t benefit from tax relief.
So, in simple terms, the MPAA places a stricter limit on the amount of tax-efficient pension contributions you could make in the future.
You could avoid triggering the MPAA by:
- Delaying drawing from your pension if you have other sources of income
- Buying an annuity
- Utilising the tax-free element of your pension – as discussed above, this is usually 25% of your pension’s value, up to the LSA.
When planning your pension withdrawals, it’s also important to remember that this money is potentially subject to Income Tax in just the same way as your salary.
2. Think about when to claim your State Pension
The current State Pension Age is 66, rising to 67 by 2028. However, there is no obligation to claim your State Pension when you reach the requisite age.
Indeed, taking your State Pension later in life could offer several benefits.
Firstly, your State Pension will increase every week you defer, as long as you defer for at least nine weeks. As a result, you could enjoy a higher income when you do decide to claim your State Pension.
Secondly, your State Pension counts as taxable income. So, if you’re still working, this will be added to your regular income and taxed at your highest marginal rate. In contrast, if you have other funds to draw on, taking your State Pension after you’ve stopped working could mean you’ll pay less tax on it as you won’t also have a taxable salary.
What’s more, deferring your State Pension is simple – it will automatically defer until you claim it.
3. Use ISAs and other investments to bridge the income gap
If you have built up a healthy amount of tax-efficient savings in ISAs, you could use these to bolster a part-time income.
In the 2024/25 tax year, you can save and invest up to £20,000 in ISAs. You’re then shielded from Income Tax, tax on dividends, or Capital Gains Tax on any interest or profits you generate.
What’s more, you can make tax-free withdrawals from your ISAs at any time – unlike a pension that you cannot access until you meet the minimum age requirement.
You might also have an investment portfolio or other assets, such as property, to draw on during your flexi-retirement.
However, it’s worth remembering that the longer you keep your money or assets invested, the more potential they have to grow. By withdrawing funds, you could miss out on this potential growth.
Additionally, any investments held outside an ISA wrapper may incur tax. For example, you might have to pay Capital Gains Tax on any gains you realise above your Annual Exempt Amount on non-ISA assets, which is £3,000 for the 2024/25 tax year.
A financial planner can help you create a sustainable income during your phased retirement and beyond
Planning how to maintain the income you desire during your phased retirement and beyond can be complicated.
You might decide to draw on your savings and investments so that you can preserve your pension. Or it may suit you better to supplement your income with funds from all of these sources.
A financial planner can review your unique financial situation and help you create a tax-efficient, sustainable income that affords you the lifestyle you desire.
If you’d like to know more about incorporating a phased retirement into your financial plan, we can help.
Please contact us by email at info@lloydosullivan.co.uk or call 020 8941 9779 to see how we can help you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pension Regulator.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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