Now that it’s possible to draw your pension at 55, early retirement is possible for many more of us – at least in theory.
It’s also much easier to take phased retirement, where you continue to work (probably fewer hours) while cashing in your pension.
Here are the issues to think about if you want to take your pension early and still work.
Can I take my pension early and continue to work?
The short answer is yes. These days, there is no set retirement age.
You can carry on working for as long as you like, and can also access most private pensions at any age from 55 onwards – in a variety of different ways.
You can also draw your state pension while continuing to work.
You can start receiving your state pension from your state pension age (currently 65 and increasing to 67 from 2028) regardless of whether you choose to retire then or not.
If you wish, you can choose to defer your state pension if you don’t need the income yet, for an increased pension later on.
Is there a downside to taking my pension early and continuing to work?
The main drawback of continuing to earn money while drawing a pension is that you will lose more of the pension in tax.
All pension income is treated exactly the same as any other kind of income, so you’ll pay income tax on everything over your personal allowance. This will reduce some of the tax-saving benefits of having the pension.
Find out how much retirement income you might receive (before tax) from your private pension pot and how to boost it by using our Pension Calculator.
Another possible drawback is a reduced annual allowance. If you have started to draw on your pension, but want to continue making contributions into it, then your annual allowance will be much smaller.
You may also want to check you don’t exceed the lifetime allowance.
How much tax will I pay on my pension if I am still working?
The tax you pay on your pension will depend on how much you’re still earning.
All your income above £12,500 (the annual allowance) is taxed at 20 per cent, and all your income above £50,000 (the higher rate tax band) is taxed at 40 per cent (until you reach £150,000 – everything over that is taxed at 45 per cent).
Therefore any earned income will use up some or all of your annual allowance, exposing more of your pension income to tax. Here’s an example.
Clare receives the full new state pension, and also has an annuity that pays her £8,000 a year. She also makes £10,000 a year as a sole trader from her homemade jewellery business. Her total income for the year is therefore £27,627. After her personal allowance of £12,570 this leaves £15,057 to be taxed at 20% – which is £3,011. Clare’s net income after tax is therefore £24,616.
State pension income
Taxable income (at 20%)
Income tax bill
Note that if Clare were to take just £7,000 a year via her private pension, her tax bill would be £2,811 and her net income £23,816. This is only £800 less income, but she would have saved £1,000 in her pension. This suggests that in her case she might be better off with a drawdown scheme rather than an annuity. With drawdown, she could keep her pension income lower while she is earning, thus saving money and tax, and then raise it when she stops work completely.
Do I pay National Insurance contributions on my pension income?
You won't pay National Insurance (NI) contributions on your private pension income whether or not you've reached state pension age.
However, you will pay NI contributions on income generated from employment or self-employment that is over the set thresholds, unless you are over state pension age.
What are the advantages of drawing my pension while continuing to work?
Not everyone wants to stop work abruptly and move instantly into full retirement.
It is becoming increasingly popular to reduce your working hours (assuming your employer will enable this) and move into retirement gradually. This can be better for both your physical and mental health.
Similarly, you may want to leave your current job altogether but run your own business in retirement.
This is a very popular route for early retirees; there may be a money-making scheme you’ve been itching to try, but have lacked the time or energy to pursue it while working full-time.
Retirement can offer the opportunity to put your creativity to work, without the need to support yourself immediately via your business – because you’ll have your pension income available.
If I’m phasing my retirement, how should I draw my pension?
You will need to talk to your financial adviser about the best way to take your pension.
Everyone’s circumstances and needs are different, so it is impossible to say that one particular route will be suitable in a given situation.
However, if you are likely to be receiving other forms of income for a while (such as wages, business income, or rent from buy-to-let properties), then you may want to be able to vary your income based on changing needs.
This might make drawdown a more suitable option than an annuity – but do discuss this with your IFA before jumping to any decisions.
Other benefits of phased retirement
As well as making financial sense, easing into retirement can be better for your health and mental wellbeing.
Sudden lifestyle changes are usually stressful, even when they involve being under less pressure, and many people in early retirement miss the structure and purpose that working brings.
What’s more, working full-time doesn’t give you much time to think about retirement, or any real sense of what it might be like.
So entering a partial retirement first may give you not only a valuable taste of what’s to come, but also the time and knowledge you need to plan ahead for the real thing.
Remember, your financial adviser can also help a lot with the practical and personal sides of preparing for retirement.