Early retirement planning

Author Image The Technical Team
7 minutes read
Last updated on 6th Apr 2019

Overview

For the young and those with good levels of disposable income the dream of an early retirement at 55 could be achieved by bridging the income gap before State Pension is payable.

Key points

  • By using a Flexi-access drawdown contract it is possible to provide the equivalent of the income provided by the State Pension, earlier than the State Pension retirement age.
  • How to provide income at the approximate level of the State Pension from age 55 until the State Pension becomes payable at State Retirement Age.
  • Since the income requirement is limited to the period between age 55 and State Retirement Age (and not to provide an income for life) funding may not be as expensive as perhaps anticipated.   

Bridging the gap

For many clients the idea of retiring at age 55 has been long since given up, but for the young and those with good levels of disposable income the dream of an early retirement could still be achieved, with a little help from recent reforms.

It is worth noting that since the advent of pension freedoms there has been a marked increase in those age 55-59 that are accessing their pensions. Please note that the early retirement planning in this article is looking towards the State Pension and not any further income that clients may require.

Background

The Taxation of Pensions Act 2014 introduced a series of pension reforms designed to increase pension flexibility and encourage savings. But against this the State Pension Age (SPA) has been steadily increasing and is likely to continue to increase given the decision to review it each parliamentary period as announced in the Autumn Statement 2013.

Those wanting to have control over the age they wish to retire, without having to wait until the State pension benefit commences at State pension age, need to take action. The sooner that action is taken the less it will likely cost. This article looks at how pension's flexibility could make this even more attractive.

But how can control be kept? By using a Personal Pension or similar arrangement, and it needn't cost the earth. In the past, to provide a pension income a sizable fund was required (perhaps twenty times the income required, based on a 5% annuity rate) as the income could not be tailored to a specific number of years and had to continue for the life of the annuitant. This is no longer the case as under the reforms it is now possible to withdraw pension funds as required. The fund used to provide for this early retirement must be large enough to provide an income that meets the client's income requirements for the term between when the pension is accessed (say age 55) and the State Pension Age (taken as age 67, as this is the age that is likely to be relevant to many clients).

However, it is important to note that the Government plan to raise the minimum age at which an individual can take their private pension savings from 55 to 57 in 2028, at the point that the State Pension age increases to 67.

The figures below are all based on there being a 12-year gap between the point the client wishes to retire (age 55) and when the Basic State Pension becomes payable, so if this is reduced to 10-years it would mean the costs discussed are likely to be less than described here.

The new State Pension, assuming qualification for the full benefit, is £168.60 (2019-20) per week and as such this is the figure we will use in the following example. Over 12 years this gives approximately £120,948 of total payments allowing for increases at 2.5% at the beginning of each year, being the minimum under the 'triple lock' guarantee. It's important that the guaranteed escalation is taken into account as otherwise the total payments would only be approximately £105,206 - a difference of £15,742.

Of course, as this is a minimum increase provided under the ‘triple lock’ guarantee, it could increase above this rate potentially leading to an increase in income when moving from bridging to the new State Pension. It could also decrease if the “triple lock” was removed. However, if we were to assume an increase at a rate above 2.5% this could lead to the client experiencing a fall in income at the end of the bridging period so it is perhaps safer to work on 2.5% and see any increase as a bonus.

However, the above doesn’t take into account the increases in the income requirement from the point of starting any pension arrangements to the date of retirement, which will impact considerably over the longer timescales. Neither does it take into account the growth on the fund as it decumulates by paying out the required income. The case study below attempts to provider a truer picture of the costs in funding for early retirement. The cost of building this up depends on three factors: the client’s age, the increase in the income required from current date until crystallisation at age say age 55, and during the 12-year term from crystallisation until age 67 (State Pension Age), the net return expected charges and the client’s tax position.

 

Case study 1

In our case study we have calculated the annual cost of providing a bridging pension, to replace the full amount of the current new State Pension of £8,767.20 per annum for a 12 year period, from age 55 to the anticipated state retirement age of 67. We have assumed that the income required increases at 2.5% pa until age 55 and this rate of increase continues in the 12 years that the income is required (Nil PCLS payable). We have also assumed a 5% pa growth rate (net of Annual Management Charge) on the funds during both the accumulation and decumulation phases.

Age Now

Initial annual income required at age 55 to replace current value of £8,767 (revalued at 2.5%pa until age 55, in advance)

Total Gross Income between age 55 and 67 Fund required at age 55 to meet total gross income requirement of 12 year period (excluding adviser charging) Gross Level Annual Premium Required to provide required fund

Total Gross Cost over term

Total Cost (20% relief) over term*

Assumes all contributions fall into basic rate tax band

Total Cost (40% relief) over term*

Assumes all contributions fall into higher rate tax band

30

£16,254

£224,232

£171,428

£3,592

£89,796

£71,837

£53,877

35

£14,366

£198,188

£151,517

£4,582

£91,645

£73,316

£54,987

40

£12,698

£175,169

£133,919

£6,206

£93,092

£74,473

£55,855

45

£11,223

£154,824

£118,365

£9,411

£94,105

£75,284

£56,463

50

£9,919

£136,842

£104,617

£18,933

£94,665

£75,732

£56,799

*  - assumes UK tax rates - Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. The figures will be different for those subject to SRIT

Summary

For a 30 year old higher rate tax payer, a net outlay of £53,877 (spread over a 25 year term) will generate a fund sufficient to replace the anticipated future value of the current gross guaranteed minimum pension from age 55 to 67 (based on the assumptions being met).

For a 50 year old higher rate tax payer, the net outlay (spread over 5 years) is £56,799; however this produces a gross total income of over 2.4

 times this outlay, over the important years between 55 and 67.

If this is the only income being received it would result in no income tax being payable. This idea could be extended to include the full personal allowance for the term of the bridge for maximum tax efficiency.

To provide a 45 year old with an income equivalent to today's current Personal Allowance (£12,500) at age 55 would require an initial income of £16,001 pa (assuming 2.5% inflationary increases) this income requirement would continue to rise to £20,995 by SPA. The total income that would be paid over the 12 year term (until age 67) would be £220,743. The outlay over 10 years to produce this fund would be £13,417 per annum gross. For a higher rate tax-payer that results in a total net outlay of £80,504. The gross income received over the 12 year period is over 2.7 times the net outlay.

Is this value for money? Well the figures certainly indicate that it is, but how can you put a monetary value on an extra 12 years of retirement? With all the talk of working to age 70 etc. it’s refreshing to know that with good retirement planning, the equivalent of the new State Pension can be provided from age 55 and this level of income can continue until the new State Pension age is eventually reached. It’s important to remember that the state pension alone is unlikely to be able to provide sufficient income in retirement for a great many people, and further planning over and above this would be needed. However, if this level of income is sufficient, retirement at age 55 can still be more than just a dream for a great many clients.

Labelled Under:
Retirement income

© Prudential 2019