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Looking at Phased Retirement By Way of an Example Calculation

Looking at Phased Retirement By Way of an Example Calculation

Here, we provide readers with a useful example regarding phased annuity purchase – perfect for your CII R04, J05, AF7, or AF8 exam preparation.

THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2020/21.

Someone wishing to phase their retirement can do so by either crystallising just part of their pension fund and gradually crystallising the rest over the next few years, or if they have separate policies, they can be crystallised at different times; this is known as segmentation.  This can be done through phased flexi-access drawdown, phased capped drawdown, phasing UFPLS, or by phased annuity purchase, which is what we are going to look at in this article by way of an example.

Example

Charlie is aged 60 and works part-time earning £15,000 per year.  He now wishes to top this up by taking an income from his uncrystallised SIPP through phased annuity purchase.  The provider does not allow partial encashment of segments. The SIPP is valued at £600,000 and segmented into 1,000 policies.  Charlie requires a net income of £15,000 in the first year and has found an annuity rate of 5.6%, which he wishes to proceed with.

How many segments need to be crystallised to provide Charlie with his required level of income?

Firstly, we determine the value of each segment of Charlie’s SIPP: £600,000 ÷ 1,000 = £600

This provides 25% PCLS and the remaining 75% provides the income:

  • £600 x 25% = £150 (PCLS)
  • £600 x 75% = £450 x 5.6% = £25.20 gross (annuity income)

Charlie requires a net income, so we now need to deduct basic rate income tax – £25.20 x 80% = £20.16.  We can now establish the total net income per segment:

  • £150 (PCLS) & £20.16 (net annuity income) = £170.16

Next, we work out how many segments need to be crystallised to provide the amount of net income:

  • £15,000 (target income) ÷ £170.16 (net income per segment) = 88.15

This tells us we need to crystallise 88.15 segments to achieve the required net income; however, as the provider doesn’t allow partial encashment, we round this up to 89 to provide Charlie with an income of:

  • 89 x £170.16 = £15,144.24

The income is made up as follows:

  • 89 segments x £150 (PCLS) = £13,350
  • 89 segments x £20.16 (net annuity income) = 1,794.24
  • Total net income £15,144.24
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What difference would it make to Charlie’s income if the SIPP was not segmented?

This time, as there are no segments, we need to establish the income available per £100 of the fund:

  • £100 x 25% = £25 (PCLS)
  • £75 x 5.6% = £4.20 (gross annuity income)

Charlie’s target income is net of basic rate tax, so we need to deduct this to determine net income:

  • £4.20 x 80% = £3.36

So, we know for every £100 of fund Charlie can have a net income of:

  • £25 (PCLS) + £3.36 (net annuity income) = £28.36
  • This gives an annuity rate of 28.36%

We then divide Charlie’s target net income figure of £15,000 by the annuity rate calculated above:

  • £15,000 ÷ 28.36% = £52,891.40

This is the amount of fund Charlie must crystallise in order to produce a net income of £15,000.  Again, we can check this by:

  • £52,891.40 x 25% (PCLS) = £13,222.85
  • £52,891.40 x 75% x 5.6% (annuity rate) = £2,221.44 (gross income) x 80% = £1,777.15 (net income)
  • Total net income = £13,222.85 + £1,777.15 = £15,000

Phased retirement can be tested in any of the CII pensions exams but notably R04, J05. It is also useful knowledge to have for those studying AF8.

Grab the resources you need!

If you’re studying for your CII R04 exam, and you’re wondering how you’ll ever manage a pass, grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the R04 calculation workbook taster now!

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Alternatively, you can download a taster for AF7 or J05 if you are preparing for either of those exams.