by John Spink
Head of Financial Planning
Many of our clients are business owners, so we know that all too often people consider their business to be their pension and as such overlook the need for wider retirement planning.
While this view is completely understandable and is often down to being too busy managing the day to day activities of the business, there are four key risks with this strategy:
While you’ve probably got a retirement date in mind, what position will your business, the economy and markets be in when that age rolls around?
You could face a situation where you come to your chosen retirement age and look to sell the business but find yourself unable to do so.
This might be because the business isn’t performing as well as expected, meaning you won’t get as much cash for it as you were hoping / had planned for to meet your retirement goals.
Or the economy and markets could take a nosedive before you look to sell, which also might impact the value of the business, if you can even find a buyer in such an environment at all.
In such a situation, you could face some unfavourable outcomes. You could either:
If you decide to go down the route of entrusting your business to someone new at retirement and becoming a sleeping or silent partner still drawing a profit from the business, you have the worry that your replacement will determine whether the business is a success of a failure going forward. It will be out of your hands.
If the business then flounders, as so many businesses do when handed off to a new generation, you’ll have lost a vital source of retirement income.
A big part of our job is to educate our business owner clients and help them to think beyond their business. We want them to understand what good financial planning looks like and make sure they are making the most of their allowances and are suitably diversified when planning for their financial future.
As in business you would not rely on one customer to drive the longer term success of your company, so it’s best not to depend on one investment or financial planning solution to secure your financial future.
Sound and considered business planning should go hand in hand with your personal plans for the future especially when there are generous annual allowances and tax savings available which would be lost if not utilised.
Many of our clients’ spouses are often employed within the company, providing the opportunity to double up on the allowances and subsequent tax savings. This has the added advantages of being able to utilise two personal allowances in retirement as well as not being limited to one lifetime allowance (currently £1,055,000).
Your limited company can contribute pre-taxed company income to your pension. Because an employer contribution counts as an allowable business expense, your company receives tax relief against corporation tax, so the company could save up to 19% in corporation tax.
Another benefit is that employers don’t have to pay National Insurance on pension contributions. The National Insurance rate for 2019/20 is 13.8%, so by contributing directly into your pension rather than paying the equivalent in salary, you save up to 13.8%.
This means that in total, your company can save up to 32.8% by paying money directly into your pension rather than paying money in the form of a salary.
An employer can contribute up to 100% of your salary to a pension on your behalf. This means, for a typical husband and wife duo paying themselves a minimal salary of £12,500 in the 2019/20 tax year, your company can contribute a total of £25,000 per annum.
Director 1 Annual Pension Contribution: £12,500
Director 2 Annual Pension Contribution: £12,500
Total Pension Contributions After 20 Years
Pension Pot at 65 Assuming 2% Annual Growth
As you can see, even if they delayed starting any pension contributions until they were 45, a couple engaged in running a business could have a combined pension pot in excess of £600,000 by the time they were 65.
This doesn’t even take into account personal pension contributions you might make over this period; it’s simply ones made by the company at 100% of their annual salary of £12,500.
This would provide a monthly pension of £1,301.58 per month each in drawdown if you wanted the fund to last until you were 90. This assumes growth at 2% and inflation at 2% over your retirement.
Alternatively, if you bought an annuity, you could expect an annual income of around £15,000 a year each for the rest of your life, no matter how long that would be.
We’ve made a number of assumptions about the individuals above and their pension funds to come to their estimated retirement incomes from drawdown and an annuity. For personalised recommendations and income scenarios, don’t hesitate to get in touch.
Your contributions must abide by the rules for allowable deductions. The rules state that the pension contributions should be ‘wholly and exclusively’ for the purposes of business. To figure out whether this is the case, HMRC looks for certain evidence, for example whether other employees are receiving comparable remuneration packages.
In addition to the tax saving benefits you will have also lost the potential opportunity to purchase your company property via your pension fund along with the following tax advantages:
Whilst running a business can be extremely rewarding, it doesn’t come without risk. Life has a habit of thrown in the unexpected which at best can cause unwanted stress and at worse can end in bankruptcy.
Since the year 2000 your pension fund is protected against any claim by the Trustee in Bankruptcy. This applies to all assets within your pension including any commercial property that may have been purchased.
The only occasion where a claim could be made in this scenario is against what could be considered as ‘excessive contributions’ paid to the pension scheme. You may be seen to have paid excessive contributions, especially if you’ve paid in unusually high levels of contributions and they can prove that you have done this to deliberately deprive your creditors of money owed. This could cover any contributions paid up to 5 years prior to your bankruptcy.
With all these factors in play, there are clear risks to relying on your business to be your pension, as well as rewards you’ll miss out on by doing so.
As mentioned, it’s never wise to put all your eggs in one basket and rely solely on the success of your business to fund your retirement goals and dreams because a lot could happen between now and retirement.
You don’t know what position you or your business will be in at your expected retirement date — for this reason alone, we’d suggest making other arrangements is a sensible precaution.
Our goal is simple: to improve our clients’ financial wellbeing.
We help our clients take control of their finances by building lasting relationships where we support them to make informed decisions.
We provide financial advice services to individuals and businesses throughout the UK. Whether it’s setting up personal insurance to protect your lifestyle, managing your pensions, investments and other assets to improve your financial future or setting up employee benefits for a company, we’re here to help.