Phased retirement

Going part-time and topping up from a pension, without walking into the traps.

Retirement used to be a date. For a growing number of people it's a process: dropping to four days, then three, then occasional work, over several years.

Financially it's often the strongest option available, and it's the one most likely to rescue a plan that doesn't quite work. It also has two traps in it that catch people who arrange it casually.

Why it works so well

Reducing your hours rather than stopping does three things at once.

You're still earning, so your pension funds less of your spending.

Your pot keeps growing and, if you're still contributing, keeps being added to.

It's fewer years to fund. Retiring fully at 65 rather than 60 removes five years of withdrawals from the start of the sequence, which is exactly where withdrawals do the most damage.

That third effect is why working longer is the most powerful lever in If the numbers don't work, and phasing captures most of the benefit while giving you a good deal of what you wanted from retiring.

There's a non-financial argument too. Stopping work abruptly is a bigger adjustment than people expect, and a gradual exit tends to go better.

How the income usually works

Most people phasing combine reduced salary with a top-up from somewhere.

Tax-free cash is the cleanest top-up, because it doesn't add to your taxable income and doesn't trigger the MPAA. See Tax-free cash.

Taxable pension income works, but it stacks on top of your salary at your marginal rate, and it triggers the MPAA.

ISA withdrawals are tax-free and don't affect anything.

A defined benefit pension taken at its normal age, alongside part-time work, is common and straightforward, though check whether taking it early carries a reduction.

Trap one: the MPAA

Taking taxable income flexibly from a defined contribution pension permanently reduces your annual allowance for future defined contribution contributions from £60,000 to £10,000.

If you're still working and still contributing, that's a significant constraint, and it cannot be undone.

The ways round it:

Take only tax-free cash, which doesn't trigger it
Take a small pot of under £10,000 in full, up to three of them, which also doesn't
Draw on ISAs instead
Take a defined benefit pension, which doesn't trigger the MPAA

The mistake is drawing a modest taxable income from a SIPP to bridge a gap, without realising it has capped your contributions for the rest of your working life. See Which pot do you spend first?.

Trap two: the tax on the combination

Pension income stacks on top of salary. Your Personal Allowance is used by your earnings first, so pension withdrawals are taxed at your marginal rate from the first pound.

Someone dropping to three days on £45,000 and drawing £20,000 of taxable pension has a total income of £65,000 and is a higher rate taxpayer, despite feeling semi-retired.

Two consequences worth planning around:

Reducing your hours further may be more tax-efficient than it looks, because less salary means more of your pension income falls in the basic rate band.

The order matters. Using tax-free cash and ISAs while your salary is still using your Personal Allowance, and saving taxable pension income for after you stop, is usually more efficient than the reverse.

The employment side

Check your pension scheme's rules. Some workplace schemes stop employer contributions if you drop below a certain number of hours, and some defined benefit schemes have specific partial retirement provisions.

Check what happens to your benefits. Death in service cover and group income protection are often tied to salary or to a minimum contract, and reducing hours can reduce or end them. See What you already have.

Some schemes have formal partial retirement arrangements that let you take part of your pension while continuing to work and accrue. The NHS scheme is one — see Retiring from the NHS. If yours has one, it's usually better than improvising with a private arrangement.

Get the reduction agreed properly. An informal arrangement to work fewer days can evaporate when your manager changes.

The State Pension interaction

Once your State Pension starts, it uses most of your Personal Allowance on its own. If you're still working at that point, every pound of earnings is taxed from the first pound.

You can defer the State Pension, which increases what you eventually get. That suits someone still working and paying higher rate tax, since taking it would mean paying 40% on it. Whether deferring pays off depends largely on how long you live, so it's a judgement rather than a calculation.

You stop paying National Insurance on earnings once you reach State Pension age, which makes continued work meaningfully more attractive from that point.

Modelling it

Phasing is harder to model than a clean stop, because income comes from several places at once and the tax interacts.

The Retirement Readiness Calculator will show you what a later full-retirement date does to the projection, which is the biggest single variable. For the year-by-year tax of a specific salary-plus-pension combination, the Income Tax Calculator will do the arithmetic on any given year.

If you're arranging this seriously, it's worth having modelled properly. The MPAA decision in particular is permanent, and it's the kind of thing that's obvious in advance and irreversible afterwards.

This article is for general education only and isn't personal advice.