The main aim of phased retirement, or staggered vesting as
it is also known, is to provide pension
income flexibility at retirement. Although an individual
can accumulated a number of separate pension arrangements
over their working life and take benefits from each at different
times, a specific phased retirement pension plan will provide
the maximum control and flexibility.
This is because the plan is divided into 1,000 segments allowing
the individual to gradually convert their pension fund to
income by using a number of segments each year to provide
the desired level of income. However, the protected rights
portion of the pension
fund must be ring-fenced and placed in a single segment.
At the time of encashment part of the pension can be taken
as a tax
free lump sum and the balance must be used to purchase
pension annuities, providing a guaranteed income for life.
The following are a number of advantages of phased retirement
that reflect the benefits of deferring taking pension annuities
The pension fund not encashed remains
in the phased retirement plan and continues to be invested,
thus providing the individual with the possibility of
higher future income. This depends largely on how much
income is taken out of the pension fund (especially in
the early years) and future investment returns achieved
on the residual pension fund.
The individual can change
the shape of their retirement income to reflect their
personal circumstances in the future, although once a pension
annuity is purchased, this income payment will continue
for the rest of their life.
As they get older there is the prospect
rates rising and providing the annuitant with a higher
income. This is because it is cheaper for insurance companies
to purchase an annuity to provide a given level of income
for someone age 70 than someone age 60, assuming the returns
provided by medium to long-term gilts remains the same.
This is because life expectancy (years left to live) is
expected to be shorter for a 70 year old so less pension
fund is required to purchase the same level of income
as the mortality figures show. The expectation is that the insurance company
will pay out income for a shorter period of time. The
annuity is purchased by cashing in those contracts not
previously cashed in or 'vested' to provide benefits in
the form of a pension income.
By delaying the purchase
of a pension annuity the individual is more likely, due
to age, to suffer from an illness that will then mean
they qualify for enhanced
rates or even impaired
rates. This could greatly increase the pension income
payable for the rest of their life.
If the individual is nearing
retirement age and has recently started smoking 10 cigarettes
or more per day, delaying the purchase of an annuity until
they have been a smoker for 10 years or more could mean
they qualify for enhanced rates. This could significantly
increase the pension income payable for the rest of their
If the individual's market
expectations are that medium to long term interest rates
and gilt yields may rise, income might also rise as the annuity
rates for pension income shows. If this happens, they
will be able to achieve a higher amount of income, through
the purchase of an annuity, for the same amount of pension
fund 'cashed in'.
The remaining pension fund
being the policies not cashed in or "vested"
can normally be returned to the individual's beneficiaries
free of Inheritance Tax on his or her death.
The individual can use the tax free
cash as 'income' and thus, for a given level of income,
reduce their liability to income tax.
The following are a number of disadvantages of phased retirement
that reflect the opportunities lost of deferring taking a
pension annuity until later:
There is no guarantee that your income
will be as high as that offered under the compulsory
purchase annuity or transfer routes referred to earlier.
You may not receive all
of your tax free cash as a lump sum at outset, because
you are using this cash to supplement your income.
You may still purchase annuities to
provide income whenever you draw part of your tax free
cash sum. Of course, annuity rates at that time may not
The value of your remaining
pension fund, when aggregated with any annuity you have
purchased, may not achieve the required level of growth
to maintain income levels at the same level to those achieved
through the purchase of a compulsory purchase annuity
(Option One & Two of this report). This is because
withdrawals of tax free cash and annuities purchased may
erode the value of your pension fund, if investment returns
are not sufficient to make up the balance (including charges
for the ongoing administration of the plan).
Deferring the purchase
of the annuity does not guarantee a higher level of income,
as annuity rates can go down as well as up and the value
of the continued investment of your pension fund may go
down as well as up.
Annuity providers make
a profit from the fact that some individuals die sooner
than is expected. They utilise some of this mortality
profit to enhance current annuity rates. By delaying
the purchase of your annuity, the benefit of this potential
profit, which can be significant, may be lost. This is
especially true the longer you defer the purchase of an
You may feel that the prospect of future
higher income does not compensate you for not being able
to enjoy a guaranteed and secure level of income today
and for the rest of your life.
If you have not purchased
annuities by age 75, at that point you will have to purchase
a pension annuity at the rates current at that time.