Phased Retirement

You do not have to crystallise a whole pension at once. You can move part of it into drawdown, take the tax-free cash from that part, and leave the rest untouched.

Say you have a £400,000 pot and you need £15,000 a year to bridge the gap left by dropping to three days a week. Rather than crystallising the lot and taking £100,000 of tax-free cash you have no immediate use for, you crystallise enough each year to produce what you actually need. The uncrystallised remainder stays invested, and its 25 per cent tax-free entitlement stays intact for later.

This is the main structural advantage of phasing. You are not committing the whole pot to a decision you have to make years before you need to.

Income tax is charged year by year, so spreading withdrawals across several tax years usually beats taking a large amount in one.

The personal allowance is £12,570 and is currently frozen. Basic rate tax applies up to £50,270. If your part-time earnings are £20,000, you have roughly £30,000 of basic rate band left before higher rate tax starts. Drawing pension income up to that point costs you 20 per cent. Drawing beyond it costs 40 per cent on the excess. Knowing where that line sits each year, and stopping at it, is most of the tax planning in phased retirement.

An approach that often works

Take the tax-free cash from a slice of the pension to cover part of your spending, and take just enough taxable income to use up the remaining basic rate band. The blend means the effective rate of tax on the money you draw can be well below 20 per cent.

If you are still working, you may well still be paying into a pension and receiving employer contributions. Taking taxable income from drawdown triggers the money purchase annual allowance, which cuts what you can contribute to £10,000 a year and removes carry forward.

Taking only tax-free cash does not normally trigger it. Neither does taking a small pot lump sum from a personal pension worth £10,000 or less, and you can do that with up to three such pots. So someone who wants extra cash but also wants to keep contributing at a high rate has options, provided they are used in the right order. Get the order wrong and the restriction cannot be undone.

State pension age is currently 66 and is rising to 67 in stages between 2026 and 2028. A further rise to 68 is legislated for the 2040s. You can check your own date and your forecast on the government’s website, and it is worth doing rather than assuming, because the phasing depends on your date of birth.

The full new state pension normally requires 35 qualifying years of National Insurance, with at least 10 years needed to get anything at all. If you have gaps, voluntary contributions are sometimes very good value, though not always, so check the forecast before paying anything.

You can defer taking it. Under the new state pension, deferral increases the amount by 1 per cent for every nine weeks you put it off, which works out at just under 5.8 per cent for a full year. For someone still earning at higher rate, deferring can make sense both for the uplift and because the state pension is taxable income you may not want on top of your salary.

Reducing your hours affects more than income. Death in service cover usually ends when employment does. Employer contributions may stop or be scaled back. If you have a defined benefit scheme, taking it before its normal retirement age generally means a permanent reduction, and the size of that reduction varies a lot between schemes.

We look at all of it together rather than in isolation, because the pension decision and the working decision are the same decision.

Heritage has been advising people in Somerset and the South West since 2000. We are a family run firm, independent, and directly authorised by the Financial Conduct Authority under firm reference 624976. Phased retirement tends to need reviewing every year, because your earnings change, the tax bands change and your plans change. That ongoing conversation is where most of the value is.