Early retirement – a question of profit or loss

Pensions

MoneyPlus Features Team

3rd June 2015 at 10:01am

What makes more of a difference to you – how much you’ll lose or how much you’ll gain?

Actually research shows that losses hurt more than gains. And behavioural psychologists would argue pitching early retirement as ‘see how much less you’ll get if you retire now’ as opposed to ‘see how much more you’ll get if you delay’ would provide a much bigger incentive for people to hold off or think twice. Just a subtle play on words could influence one of the most important decisions you’ll have to make in your financial life.

With new pension freedoms coming into effect in April this year, we’ve now more options than ever on how we take our money in retirement and as result we need to be asking ourselves some important questions, however it’s critical we frame them properly and without bias.

Should your heart rule your head?

When imagining working longer our emotions can perhaps rule our heads. For example, we might tend to focus on the worst parts of working rather than the comfort and security we could enjoy later on if we worked a few years longer. There’s a danger we bring in our own bias, potentially jumping at the chance to retire because we think working on will be worse than it is, and because we think life in retirement will be better than it is.

Does it all stack up?

For some retirement can be purely a financial calculation. You know you’re financially ready when the combination of all your investment income produces enough cash to cover all of your anticipated expenses for the rest of your life. But working two or three more years could make a difference to your long-term plan if you continue to save. It’s also worth factoring that into your calculations and seeing how much you could lose by stopping now. It could help rationalise your decision.

Phasing in that final day

But remember, retirement needn’t be an all-or-nothing decision – it’s not a case of you’re either still working full-time or you’re completely retired. You’ve a lot more choice now than previous generations enjoyed.

You could widen your alternatives and consider working part-time. Your primary goals should be happiness and fulfillment. You don’t necessarily have to stop working to achieve them.

You might enjoy the retired life more if you find part-time work that provides some income while giving you the time out to do what you want in your non-working hours.
As a result, it’s always worth considering phasing in your retirement. Many employers will let you switch to a phased retirement track, working part-time and gradually cutting back those hours until you’re ready to retire completely. Ask your employer about the possibility. You might be surprised by the answer.

A tax-efficient time out

And phasing in your retirement and taking that time out doesn’t always need to mean a drop in income. You could subsidise any shortfall with your pension. A tax-efficient way of doing this could be to draw your pension in stages, particularly if you choose an option known as income drawdown. This allows you to draw the money you need directly from your pension, and keep the remainder invested and under your control. You’ll be able to dip in and make as many withdrawals as you want, each time getting 25 per cent tax-free (assuming you’ve not already taken all your tax free cash) with the rest taxed as income. Providing you get your investment decisions right, whatever you haven’t spent could still be growing, but it’s always worth remembering there’s a chance it could drop too.

Weigh up your options

It’s always nice to know you’ve got options but it’s even more comforting to know that any decisions you make are informed and the right ones for you. Retirement choices are some of the biggest financial decisions you make in your lifetime, so it’s important to take time, look at all the alternatives and make sure you frame them correctly before taking that welcome leap into life after work.

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This blog and any responses to comments are not financial advice. This blog is only an illustration and other approaches are possible. Tax and legislation can change in the future and this represents our understanding of the rules in May 2015. A personal pension is an investment. Its value can go up or down and may be worth less than you paid in.