Contractors gain substantial tax savings when they contribute to their pensions but will soon also benefit from far greater flexibility when they reach 55.
New pensions rules announced by the Chancellor George Osborne last week have clarified the details around how contractors will now have additional ways to withdraw cash tax efficiently from pension funds in future.
“In the past a rigid annuity or a capped drawdown arrangement were the only options for most contractors at retirement. Now contractors will be able to draw multiple lump sums direct from their pension fund instead,” explains an expert independent financial adviser (IFA).
“Known as ‘Uncrystallised Lump Sum payments’ the rule change allows contractors to take ad hoc payments without drawing down the entire 25% tax free lump sum. This allows contractors to protect funds that aren't immediately needed in a tax efficient environment for the months or years until they do require the next tranche of money.”
The IFA expert highlights that these lump sums will be part taxable and part tax free and are similar to what is currently available via ‘phased’ retirement – the main difference being there is no cap on the amount of their fund that contractors can draw under the exciting new freedoms.
“The fact that part of these withdrawals include a tax free element and part will be added to a contractor’s taxable income allows for some creative use of the personal allowance to draw out funds. This could even avoid tax on the whole withdrawal.
“With this flexibility in mind, the Chancellor’s latest change to the pension rules is being dubbed the ‘bank account pension’ by the media. This is because it gives contractors the freedom to take multiple smaller withdrawals and can therefore be looked on as meeting both income needs or the desire to access capital for holidays, home improvements and so on.”
This measure is one of several pensions reforms introduced this year that also include flexible access to death benefits and in turn slashing the tax paid on inherited pensions payments to beneficiaries.
According to the IFA expert, the hugely increased flexibility around how contractors can access their pension funds means that now is an ideal time to benefit from the upfront tax savings on pension contributions made today.
He explains: “Contractors can still invest up to £40,000 per tax year either personally depending on salary or via their limited company with no link to salary. The tax saving can be the equivalent of as much as 64%, which means that for every £100 a contractor invests, in certain cases a contractor would only actually invest £36 and the taxman funds the rest.
The expert concludes: “Contractors are increasingly looking on their pension as something that can represent a lasting legacy of their time spent contracting that will provide an income for retirement and could also leave a substantial inheritance for a contractor’s family.”