How to receive pension benefits as a contractor

Ensuring financial stability during retirement is vital for contractors, so it’s important that you spend time considering your retirement goals and how you intend to achieve that financially, while you are in work, writes Hrishi Kulkarni, managing director of iSIPP.

Pensions access has been brought forward to your mid-to-late 50s

With the ability to enjoy the flexibility and the benefits of accessing your pension at age 55 (raising to 57 in 2028), you will need to consider how you will contribute throughout your working life.

Similarly, any strategy relating to how to receive pension benefits as a contractor, should factor in your preferred withdrawal arrangement, ensuring that you provide a suitable pension income while continuing to grow your pension pot.

State pension

As a contractor you will be eligible to receive the state pension upon reaching the state pension age -- 65-years-old (rising to 67-years-old between 2026 and 2028, and then 68-years-old between 2044 and 2046.

In most cases, our experience of the contractor sector suggests that the income received from the state pension will not be sufficient to meet your retirement goals.

Currently, the state pension is set at £221.20 per week (for 2024-2025), albeit for those with a full pension credit.

You need a minimum of 10 years National Insurance contributions to qualify for the state pension, and a record of at least 35 years of contributions to receive the full amount.

Personal pensions

A personal pension offers several benefits to contractors (including reducing your tax liabilities) and is a great way to supplement the State Pension and plan for a comfortable retirement.

A personal pension is a defined contribution scheme which means what you receive depends on how much you have paid in and how well your investments have performed.

Personal pensions offer contractors greater flexibility of investment options and crucially, autonomy over investment decisions to maximise potential returns and therefore achieve your retirement goals.

Pension withdrawal for contractors

Understanding your pension withdrawal options is a crucial part of preparing for retirement.

Changes introduced in April 2015 mean that as a contractor, you can access your pension using the so-called ‘flexible drawdown’ method, and can access the funds in your pension pot whenever you like (upon reaching the age of 55, or 57 from 2028).

It is a useful mechanism for those who wish to slow down their contracting career (‘phased retirement’) and maintain income through a combination of fewer contracts and the income from the drawdown.

When you're ready to start withdrawing from your pension, you can access your money in a few different ways:

Five keys to withdraw retirement funds as a contractor

1. Tax Free Lump Sum: SIPP holders can withdraw up to 25% of their pension fund subject to an overall cap of £268,275, tax-free.

After the tax-free lump sum, the remaining 75% is taxable as income at your normal marginal rate.

2. Income Drawdown (or Flexi-Access Drawdown; ‘FAD’): This is an arrangement that allows you to withdraw any amount from your pension pot while the remainder continues to be invested.

A quarter - 25% - of the amount withdrawn is tax-free, and the remainder taxed as marginal income. This option offers the flexibility to adjust income year by year, which can be advantageous for managing HMRC tax liabilities and investment strategies. It also allows for capital appreciation and additional funds to draw down in the future.

3. Uncrystallised Fund Pension Lump Sums (‘UFPLS’): A UFPLS is a withdrawal of funds directly from the pension pot.

You can use UFPLS to access your whole pot in one lump sum or as a series of lump sums.

When you take a UFPLS, 25% of the money is tax-free and the remaining 75% is taxed according to your marginal rate.

4. Annuities: An annuity offers a guaranteed income for life or fixed-term. This option provides a stable, predictable income, mitigating the risk of depleting one's pension pot too early.

Helpfully, annuities can be tailored with various features, such as escalating payouts to combat inflation or provision for pension after death.

However, once purchased, the decision is generally irreversible, making it crucial to consider the options carefully.

5. Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LSDBA):

Since Saturday - April 6th 2024, the Lifetime Allowance (LTA) is being abolished and there will be three new pension allowances:

• the Lump Sum Allowance (LSA),
• the Lump Sum and Death Benefit Allowance (LSDBA); and
• the Overseas Transfer Allowance (OTA).

While the changes mean there will be no limits on any funds used to provide a taxable pension income, there are limits on the tax-free lump sums payable both during lifetime and/or on death.

If how to receive pensions benefits as a contractor matters to you…

In the likely event that how to receive pension benefits as a contractor matters to you, it is recommended that you seek professional independent financial advice on the new changes and their impact on your retirement planning.

But to inform that consultation or meeting consider this - you can use a combination of strategies for income, such as starting with drawdown and later purchasing an annuity.

A flexible drawdown won’t suit every investor’s personal risk profile, but it does add a level of flexibility that is particularly suitable for contractors.

At iSIPP we understand the flexible working practices of contractors and can provide assistance to help you create a personalised plan which supports your retirement goals.