What are my pensions options as a contractor wanting to retire?

As a contractor, it’s important for many reasons throughout your freelance career to think about and address saving for retirement. But it’s not just all about the action of saving, and the tax relief that’s available to you in doing so!

Decide what you want from a nest egg, and when

It’s really important to think and give some thought as to what retirement you want and how you may want that to happen, financially, writes Angela James.

Many contractors now feel that what they really desire is flexibility and freedom; the choice not to work so hard or need to chase down contracts when they get near to retirement age. But what does this mean for a nest egg, and how can you use your pensions to make this happen?

Contractors often ask about pension drawdown and lump sums

We get asked a lot about ‘pension drawdown’ and pension ‘lump sums,’ so I want to demystify at least these two retirement saving options for contractors.

Before I do, please be aware that there’s no substitute for getting tailored advice when the time comes to realise your retirement and your income; it’s so important.

Most vital, is making sure you make the right decisions so that you can have a comfortable retirement and that you take income wisely -- to last the full length of your retirement.

Four main pensions options for contractors

When retirement dawns, you will have a few options to consider – four in fact:

  1. Secure income – also known as an annuity
  2. Flexible retirement – Pension drawdown (or ‘FAD,’ Flexi-Access Drawdown)
  3. Taking your pensions as a series of lump sums (or ‘UFPLS,’ Uncrystallised Funds Pension Lump Sum)
  4. Taking the whole pension pot in one go

Freedom = minefield

Thanks to the pension freedoms of 2015, we now have so much choice with pensions but actually, this can be a minefield, as options and complexity abound!

A little helpfully, contractors don’t have to choose just one of the above -- you can mix it up and do a combination. That means you are able to make these important decisions at different times throughout your retirement -- to suit your needs or health.

Let’s look at the above four pensions options, starting with the second and third.

Pension Flexible Access Drawdown FAD and Uncrystallised Fund Pension Lump Sums UFPLS

These two pensions options provide a way for you to take monies down from your pensions.

Not all providers or schemes will offer access to these options, so you may need to access advice to ensure your pension is with a provider that will facilitate the retirement you need.

But both FAD and UFPLS do provide a way for you to take monies or an income from your pension a bit at a time, while leaving the remaining pension fund invested with the opportunity to grow.

But be aware, any sums taken in excess of your tax-free allowance of 25% will be taxed as income. How much you choose to take and when is entirely up to you of course, and will be available until it runs out.

Further be aware that accessing FAD or UFPLS, will trigger the Money Purchase Annual Allowance (MPAA).

The MPAA is a reduction in your pension allowance that you can save and add to pensions through contributions in a given tax year.

Once you have triggered the MPAA your allowance will reduce from £60,000 a year to £10,000 a year. This can have consequences on your overall retirement depending on your individual circumstances.

Let’s now look at the fourth pensions option.

Taking your pension in one go

Some contractors choose to take the full amount of their pension in just one withdrawal. Should you decide to take this option, the first 25% of your funds will be your tax-free sum and the remainder taxed as income. This could create a sizable tax burden and is something to be mindful of.

The withdrawal will also trigger the MPAA and limit your ongoing options for pension savings. Fortunately, there are a set of special rules called “small pots” that could be available for you to use -- if the pension you are drawing in fully qualifies and is worth less than £10,000.

It is necessary before acting to consider your overall retirement needs and what implications this could mean for the full length of your retirement.

Lastly, let’s now look at the first pension option – what’s known as an annuity.

Secure income

Most people have heard about annuities, at some time or another.

In simple terms, an annuity provides you with a regular guaranteed income in retirement.

There are various types of annuities available in the market. The income that you would achieve with an annuity varies depending on many factors such as rates, health, type of annuity purchased.

You can buy annuities with some or all of your pension savings, at any time in retirement, and you can still take 25% of your pension as a tax-free sum, with the income from the annuity being taxed as income.

Final financial considerations -- and further pensions help

When you reach pension-access age (currently 55-years-old), it is vital that careful consideration and planning is given to any decisions you make with your valuable retirement savings. That’s even more recommended today, given the sheer amount of options to choose from and the need with the cost-of-living crisis to make your hard-earned money go further.

As a contractor, you’ll need to factor in how your retirement funds ‘fit’ in with any lifestyle choices or future plans that you have; that you don’t make costly mistakes that create additional tax implications, and that your money will last for the entire time you need it. There are many resources available; hopefully this article will join them -- and if you need further insights Pension Wise offers helpful guidance, though it’s hard to beat a financial adviser who can assess your situation and provide specific advice on the best course of retirement saving action for you and your unique circumstances.

Have a free consultation to discuss your pension options here.

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Written by Angela James

Angela is the managing director and senior adviser at Yolo Wealth our chosen advice partner. She has over 16 years’ experience in the industry, having spent the last 9 years specialising in advice to contractors and freelancers, and has worked in partnership with us during all that time.
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