3 important considerations if you’re thinking of taking a phased retirement
Your retirement date is an important milestone. Increasingly, though, many retirees are choosing to ease into retirement gradually rather than having a set date on which they stop working.
This has become known as a “phased” retirement, and it’s now more popular than ever. According to research by Legal & General, in November 2022 half of over-55s who were still in work expected to take a phased retirement, rather than a traditional “cliff-edge” retirement. Of these individuals, almost half revealed that they are doing so because they can’t afford to fully retire.
A phased retirement has many potential benefits, but there are also some important financial considerations to be aware of. Read on to learn more about what it entails, and what to think about to help you discover whether it could be the right choice for you.
Phased retirement allows you to slowly reduce your working hours
A phased retirement means reducing the amount of time you spend working gradually, rather than going from being a full-time employee one day to being fully retired the next.
This looks different for everyone. You could:
· Reduce your working hours at your existing job
· Take on a part-time job at a new firm
· Work as a freelance consultant
· Set up your own business.
The beauty of this is that you can do what you feel most comfortable with. You might feel excited by the prospect of working for yourself in this last chapter of your working life, or perhaps you’re keen to wind down and start enjoying a little bit less responsibility.
Phased retirement has many financial and mental health benefits
As well as offering you the opportunity to explore new types of work, phased retirement can also be beneficial for your finances and your health.
1. Identify how your expenditure might change
It can be a big adjustment to go from earning an income through work to relying on your pension and other savings. Meanwhile, by taking it slowly, you will have the chance to observe how this could affect your expenditure, giving you a greater understanding of how much income you will need to fund your desired lifestyle.
2. Keep hold of the aspects of work you really enjoy
The change in circumstances when you retire can be tough to adapt to. For many people, work provides a:
· Structure to their day
· Social circle
· Support network
· Part of their identity.
When this disappears, it can take time to get used to and can even trigger mental health problems such as anxiety or depression.
By continuing to work in some capacity, you can continue to see your work colleagues and maintain a structure to your day as you adjust to a new lifestyle.
3. Leave your pension invested to generate potential returns
As you continue to earn an income, you may be able to leave more of your pension invested for longer. While returns are never guaranteed, giving your pension fund more time in the market means it could have the opportunity to grow further. This could mean that you can take more income from it when you do fully retire.
4. Make further contributions to your pension
While there are some rules around contributing to your pension after you have retired (more on this below), continuing to earn an income might be a helpful way to continue to boost your retirement savings.
If you are able to enrol in a workplace pension and benefit from employer-matched contributions, this could mean even more funds can be deposited in your pension at no additional cost to you.
There are some important financial implications to consider before you decide if it’s right for you
Phased retirement has many benefits, but it’s not suitable for everyone. There are a few potential drawbacks and financial implications to consider before you make your decision.
1. You need to be sure you won’t face an income gap
If you’re reducing your hours and choosing to leave your pension invested for longer, it’s important to be sure that you’ll have enough income to support yourself and any dependents.
According to Legal & General, reducing your working hours by 15 or more each month could amount to a loss in earnings of £9,150 a year on average. So, before you take the plunge, make sure you won’t face a shortfall in income.
2. Your tax position may be slightly more complicated
Income Tax is payable on income that exceeds your Personal Allowance, regardless of whether that’s from earnings or pensions. In the 2023/24 tax year, the Personal Allowance is £12,570, so you may be liable to pay Income Tax if your total income exceeds this threshold.
Remember that the State Pension is included in this, which pays up to £10,600 in 2023/24 from age 66 if you’re eligible for the full amount.
So, if you take money from your pension alongside your income from work, for example, it could push you into a higher tax bracket. Keeping track of your income could help you to avoid paying more tax than necessary.
3. There are limits to how much you can contribute to your pension after you begin drawing an income from it
You may trigger the Money Purchase Annual Allowance (MPAA) if you continue to contribute your pension from earnings after you start to draw a flexible income from your pension pot above the 25% tax-free lump sum that you are entitled to.
The MPAA limits the amount of tax-relievable pension savings you can make, down from £60,000 or 100% of your earnings to £10,000 in the 2023/24 tax year.
If you have triggered the MPAA and you subsequently exceed this limit on contributions, you could face a significant additional tax charge.
Get in touch
If you’re considering taking a phased retirement and would like to know more about how it could affect your finances, we can help
Email info@informedpensions.com
Call 0880 788 0887
Please note
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 results.
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.
The Financial Conduct Authority does not regulate tax planning.
This article is for information 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.