In this month’s article, the Brand Financial Training team explains the process and benefits of implementing phased annuity purchase to give clients the income they need in retirement.
With market volatility and a period of higher annuity rates, guaranteed income options like annuities have started to make a resurgence. However, many clients are still understandably reluctant to commit their entire pension fund to a one-off annuity purchase, due to the loss of flexibility and potential for investment growth, and the limited death benefits. This is where phased annuity purchase can offer a less commonly discussed yet powerful income strategy that combines:
- A gradual build-up of guaranteed income through annuities,
- Tax-efficient withdrawals using PCLS, and
- Ongoing investment flexibility for the uncrystallised portion of the fund.
How phased annuity purchase works
Phased annuity purchase involves crystallising only part of the pension fund at a time, rather than all at once. With each crystallisation:
- 25% of the amount is taken as Pension Commencement Lump Sum (PCLS) which is tax-free.
- The remaining 75% is used to purchase an annuity, providing taxable income.
This approach allows individuals to tailor their income year by year, adjusting to changes in their needs, tax position, and retirement goals.
Worked example
Dravid, aged 62, decides to start drawing benefits from his personal pension using a phased annuity approach.
He requires £23,000 of gross income in year 1.
To achieve this, he crystallises £80,000 of his pension fund:
Breakdown of income:
- 25% of £80,000 = £20,000 (PCLS)
- The remaining £60,000 buys an annuity
- Annuity income = 5% of £60,000 = £3,000 (taxable)
Total gross income in year 1 = £20,000 (PCLS) + £3,000 (annuity) = £23,000
Future years
In year 2, Dravid still receives the £3,000 annuity income from year 1. So, to maintain a total income of £23,000, he only needs to generate £20,000 more which means crystallising a smaller amount of his pension.
This process continues as and when more income is required. As more annuities are purchased his guaranteed income grows. This has the added benefit that, as Dravid is older with each annuity purchase he makes, he is likely to benefit from a more generous annuity rate each time.
Over time, the tax-free portion of his income reduces, as a greater share of his income comes from annuities already in payment, and a smaller share comes from new PCLS.
If Dravid uses conventional lifetime annuities, the income is fixed and cannot be reduced once set. This can make phased annuity purchase less flexible in later years.
However, if flexible annuities are used (i.e. those that allow income to vary within limits), he can adjust the income drawn each year responding to changes in income needs, tax status, or market conditions. This addresses a key limitation of traditional phased annuity approaches.
Key benefits of phased annuity purchase
Phased annuity purchase is a powerful retirement income strategy. It offers a valuable middle ground between full annuity purchase and drawdown, combining:
- Tax efficiency: Income includes a portion of tax-free PCLS each year.
- Flexibility: Income can be adjusted annually (especially with flexible annuities).
- Gradual access: No need to tie up the full pension pot immediately.
- Growth potential: Uncrystallised funds remain invested.
- Death benefits: Uncrystallised funds retain full death benefit value (until crystallised).
About Brand Financial Training
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