While your parents and grandparents might have transitioned from working life to retirement overnight, there are now more flexible options you might wish to consider.

Indeed, research by Aviva has revealed that 40% of 55 to 64-year-olds are planning a “phased” or “flexi” retirement before they turn 65.

With higher average life expectancies than previous generations and a persistent cost of living crisis, it’s perhaps no surprise that working for longer and easing slowly into retirement is becoming an increasingly popular choice. 

If this sounds like an attractive option, read on to learn more about retiring gradually and discover three key financial factors to consider when planning your phased retirement.

A phased retirement allows you to enjoy the benefits of working while gaining more free time

A phased retirement allows you to gradually reduce your work hours as you move towards full retirement. It may mean finding a new part-time role, setting up your own business, or simply reducing your hours in your current job.

Retiring in this way offers several financial and emotional benefits.

More free time

Whether you’re eager to spend more time with your grandchildren or impatient to tick off some of the items on your retirement bucket list, moving to part-time or consulting work could give you the extra free time you need.

Boost retirement savings

People are living longer on average than previous generations and your retirement savings may need to support you for several decades.

Working for longer, even if you reduce your hours, could help boost your savings pot and allow you to enjoy the lifestyle you desire in later life.

An ongoing sense of purpose and routine

According to the World Health Organization, working can support positive mental health by providing not only a livelihood but also:

• A sense of confidence, purpose, and achievement
• An opportunity for positive relationships and inclusion in a community
• A structured routine.

Therefore, a phased retirement could boost your wellbeing by helping you maintain a sense of purpose and routine.

3 key financial factors to consider when planning your phased retirement

While a phased retirement could offer attractive benefits, you’ll need to plan your finances carefully to maintain your desired lifestyle both while you’re working and in later life.

Taking the following key factors into consideration could help you keep your long-term financial plans on track as you step back from work.

• The tax implications for pension withdrawals

Most people receive a Personal Allowance of £12,570 (2024/25) each year. This is the total amount of income you can usually earn without paying Income Tax. It’s important to note that this covers all sources of income, including your pension.

Any income you receive that exceeds this amount will ordinarily be taxed at your marginal rate.

If you opt for a phased retirement, you’ll need to plan your pension withdrawals carefully to avoid paying unnecessary Income Tax.

For example, if you can live comfortably on your earnings without relying on your pension, you might choose to keep your annual withdrawals within your Personal Allowance or, you may decide to preserve your pension completely.

This approach could also allow you to pass on more of your wealth when you die. This is because pensions don’t usually form part of your estate for Inheritance Tax (IHT) purposes. Therefore, leaving some or all of your pension to loved ones could reduce a potential IHT liability on your estate.

• The risk of falling into the “pension dipper tax trap”

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.

However, if you start to draw flexibly from your defined contribution (DC) pension, you could trigger the Money Purchase Annual Allowance (MPAA). This limits the amount of tax-efficient pension contributions you can make to just £10,000 (2024/25) and is sometimes known as the “pension dipper tax trap”.

If you plan to continue building your pension fund from your earnings during your phased retirement, it’s important to note that triggering the MPAA would significantly reduce the amount you can contribute tax-efficiently.

Fortunately, you can normally take up to 25% of your pension as a tax-free lump sum when you reach the normal minimum pension age of 55 (rising to 57 from 6 April 2028 for most people), without triggering the MPAA. This might be something to consider when planning your finances around a phased retirement.

• The potential benefits of drawing on savings and investments before your pension

If you’ve built up a healthy portfolio of savings and investments, you could use these to supplement a reduced income before drawing on your pension.

This could help you maintain a tax-efficient income during your phased retirement and beyond.

For example, if you have ISA savings, you can make tax-free withdrawals at any time. This could provide a useful top-up to a part-time income.

By drawing on other tax-efficient assets before your pension, you could avoid paying unnecessary tax on large pension withdrawals. Alternatively, as mentioned above, you might choose to preserve your pension completely to pass on to your chosen beneficiaries.

However, remember, that withdrawing savings and investments would mean that you miss out on any future potential growth these could have achieved in the future.

Moreover, any investments you hold outside a tax-efficient wrapper could become liable for Capital Gains Tax when you dispose of them if they’ve increased in value.

Get in touch

If you’re considering a phased retirement, we can help you plan your finances in a tax-efficient and sustainable way that supports your long-term goals.

Please speak to your usual Dodd Wealthcare contact. Alternatively, please email info@doddwealthcare.co.uk or call 01228 530913 / 01768 864466.

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 estate planning or 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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