Making the most of pension lump sums: overview for contractors

As a contractor, you likely have built up your pension from various projects and your own savings.

The good news is from age 55, you can start accessing these funds. Contractors can access their pension savings in several ways.

One common way is by taking ‘lump sum’ withdrawals, writes Hrishi Kulkarni, managing director of iSIPP.

But how exactly do lump sums work, and how can contractors use them to best effect? This overview looks at the key rules and considerations.

What are pension lump sums?

There are two main ways to withdraw lump sums from your pension:

1. Pension Commencement Lump Sum (PCLS)

You can take up to 25% of your pension value tax-free when first accessing benefits from age 55.

2. Uncrystallised Funds Pension Lump Sum (UFPLS)

This allows ‘one-off’ withdrawals from pension savings not yet in drawdown. Please note, 25% of each UFPLS withdrawal is tax-free, while 75% is taxed as income.

In this article, we will be focusing on the more involved of the two lump sum withdrawals -- UFPLS.

The benefits of UFPLS

UFPLS gives you flexibility to unlock cash from your pension as needed, without setting up regular drawdown income.

For example, if you have £100,000 in pension savings, you could withdraw £10,000 as a one-off UFPLS payment. £2,500 would be tax-free as a lump sum, while the remaining £7,500 is taxable income.

Lump sums taken in this way can offer several potential benefits:

· Flexibility

You can unlock cash as needed – ideal if you don’t have any regular income set-up or you need more than your regular income.

· Tax-efficiency

Contractors quite understandably tend to withdraw amounts that keep them within their lower tax band each tax year. It’s best to always consult your tax adviser to help choose the best pension income option for you and your circumstances.

· Access to cash

With UPLS, you get to release money for major purchases, or you could re-invest it elsewhere. Remember, 25% of the lump sum you will get is tax-free.

For contractors, the flexibility and tax-efficiency aspects of taking lump sums can be particularly useful. To withdraw lump sum amounts from your pension pot over time can help minimise your overall tax burden. However, UFPLS may not be appropriate for every contractor’s tax position, and you should seek professional, regulated advice.

Lump sums and limited company contractors

If you operate as a limited company, your pension is probably a SIPP -- a Self-Invested Personal Pension. The good news is SIPPs typically allow you to take lump sum withdrawals whenever you like after age 55. This gives you control over accessing tax-efficient cash.

Lump sums and umbrella company contractors

If you’re a contractor who works through an umbrella company, you likely have pensions from different workplace plans for each contract. These workplace pensions sometimes do not allow lump sum withdrawals -- you may have to take regular income.

However, you can transfer these old workplace pensions into a SIPP. This allows you to consolidate the pots and then access lump sums from the SIPP wrapper after the age of 55.

Consolidating pensions into a SIPP could make pension management simpler and can reduce costs.

Key considerations before withdrawing lump sums

Before withdrawing lump sums, key considerations as a contractor include:

• Impact on retirement -- You’ll likely want to avoid draining the pension too quickly.
• Tax implications -- Ensure you double-check how much is tax-free (with tax due on the rest).
• Provider rules -- Check any limitations or restrictions in your provider’s small print.
• Consolidating pensions -- Remember, consolidation can allow better flexibility and control.
• Get tailored advice – Expert guidance to suit your specific situation is hard to beat.

Ready to take a lump sum? Here's a step-by-step...

But what order should you do things if you want to withdraw a lump sums?

Here is a step-by-step guide to accessing lump sums from your pension:

1. Review your pension pots -- Identify old workplace pensions. Check the rules of your current providers.

2. Understand tax implications -- Calculate how much you can take tax-free.

3. Consolidate pensions -- Consider combining pots into a SIPP for greater flexibility.

4. Figure out how much income you need -- Estimate your living costs in retirement and ensure withdrawals are sustainable.

5. Withdraw lump sum -- To make the withdrawal, you simply request a one-off payment from your provider. As stated, 25% will be tax-free, with the rest taxed as income. This is also known as ‘Uncrystallised Funds Pension Lump Sum’ (UFPLS). Alternatively you can access your pension income using the Flexi-Access Drawdown option where you can take 25% tax-free and keep the remaining 75%, either invested or setup a regular income withdrawal.

6. Manage any remaining funds -- Ensure any funds left over remain properly invested.

7. Seek guidance if needed -- Take financial advice to ensure lump sums suit your situation.

Lump sums -- summed up

In summary, lump sums allow contractors to access pension cash flexibly. But care is needed to maximise tax-efficiency and ensure retirement finances stay on track. Consolidating multiple pots into a SIPP can provide greater control. Getting tailored expert advice is recommended before making lump sum withdrawals.

Disclaimer from iSIPP: With pensions, your capital is at risk. We do not provide any advice.