Pension Fund Withdrawal and Phased Retirement Combined

This option combines phased retirement and pension fund withdrawal (now known as 'unsecured income'. You may set up a phased retirement arrangement but, instead of using the segments encashed to purchase an annuity, they can be used for income withdrawals. This gives control over the continuing investments as well as the ability to defer annuity purchase.

By only phasing in the part of the pension fund you need, and not being restricted to buying a fixed annuity, you can, if you so wish, defer buying all annuities until the age of 75 or beyond. You can build up your income as and when you wish, with the added flexibility of varying the income between certain limits. With the continued investment in a tax-efficient environment and the ability to take a series of tax-free cash lump sums as part of your income, this option offers you the maximum flexibility for tax planning purposes.

Investment strategy & management

The value of the fund, the income you withdraw each year and the final pension you purchase will all be dependent upon the careful management of the funds remaining invested. It is therefore essential that a good investment strategy be adopted when starting this type of plan. Where a combination of phased retirement and PFW is entered into, this makes the investment process particularly complex as it will require a combination of the two strategies, as referred to in the previous pages.

What happens if you die ? / death benefits

The benefits available to your nominated survivor depend on how much of your pension fund remains invested. In respect of the segments not yet encashed for PFW, the value of the fund can either be paid as a lump sum, used to purchase an annuity or used for pension fund withdrawal.

In respect of the fund already being used for PFW, there are generally several options available:

Receive a cash lump sum, subject to a tax charge of 35%.
Purchase an annuity.
Continue taking pension fund withdrawals until you reaches age 75, at which point you can move into Alternatively Secured Income (ASI) and continue taking a level of fund withdrawals, or purchase an annuity (or a series of annuities).

Taxation Issues

As part of the income can be taken as tax-free cash, only the part used for income withdrawal is subject to income tax. Funds remaining invested continue to benefit from the tax efficient environment of your pension fund.

If, on death, the remaining fund opened for PFW is paid as a lump sum, a tax charge of 35% is applied.

Generally, any lump sum will be paid free of inheritance tax but, in certain situations, the Inland Revenue may apply such a tax. If you decide to take an income via Alternatively Secured Income, the death benefits are potentially liable to Inheritance Tax.

Advantages of phased / pension fund withdrawal combination plans

The combination option gives you a high degree of control over your tax planning.

It gives the flexibility to defer annuity purchase.
It gives the flexibility to take income withdrawals in stages.
A level of income appropriate to your needs can be obtained in a tax efficient manner.
Both the funds being used for PFW and the balance not yet encashed remain invested. You therefore retain control of your investment with the potential for future growth.
Income may be varied, between set limits, to suit your personal circumstances.
Flexibility in income levels may provide scope to mitigate your personal liability to income tax in certain years.
The value of death benefits may be more attractive.
You may be able to continue contributions to your pension fund.

Disadvantages of phased / pension fund withdrawal combination plans

The full tax-free cash lump sum entitlement cannot be taken at one time.
Future investment returns are not guaranteed and the value of the pension fund may fall. This may therefore result in a lower total income than if an annuity was purchased at outset.
Annuity rates may be lower in the future. As a result, the eventual annuity may be lower than the annuity that would have been available at outset.
High withdrawals of income may not be sustainable during the income withdrawal period and may also reduce the amount of any potential annuity.
The higher the level of income withdrawal chosen, the less that may be available to provide for dependants, particularly when the original fund is small and/or investment returns are poor.
Increased flexibility brings increased administration costs. Charges are likely to be higher than those relating to annuity purchase and may increase in the future.
It is possible that the level of income selected at outset may need to be decreased or increased to comply with new limits arising from a triennial review.

For whom might combined Phased Retirement and Pension Fund Withdrawal be a suitable option ?

For those who have significant levels of pension funds.
For those who may wish to defer annuity purchase.
For those who wish to maintain control over all the remaining investments.
For those who do not need the maximum tax-free lump sum in one go, particularly where there are significant levels of non-pension assets/capital to draw on.
For those who can afford to postpone taking withdrawals in periods of adverse investment conditions.
For those who are prepared to take a significant investment risk, as the entire pension fund will remain invested.
Rather than using a pension fund to buy a at retirement, individuals may prefer to drawdown on their pension fund now and wait until they are older when annuity rates may have increased.
An alternative route could be to use a proportion of the fund to buy a compulsory purchase annuity, with the remainder still kept invested (however, by age 75 an annuity must be purchased).

The options outlined above will be affected by the proposed changes in pension legislation that are due to take effect from 6 April 2006. Please refer to our pension simplification document for more details and clarification.

NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.