A common phrase we hear among entrepreneurs is that “my business is my pension.” Business owners spend their working life growing and developing their enterprise, with the intention that this will provide them with the lifestyle they want when they finally exit the business.
However, in our experience, it’s often not quite as simple as that. Extracting money from a business might not be as straightforward as you expect. And the landscape could be quite different in 20 years’ time than it is now.
While a bespoke plan is the best way of helping you to ensure you get the life you want now and in retirement, there are a couple of general strategies you can employ to build a secure and sustainable retirement plan if you’re a business owner.
Make regular pension contributions
While you may believe the money that you invest in and generate from your business might provide you with income in retirement, it’s still important to set cash aside for making pension contributions.
One of the main benefits of making pension contributions is that you’ll benefit from substantial tax relief on your contributions up to the lower of your annual earnings or £40,000 a year.
If you’re a basic-rate taxpayer, for every £100 you pay into your pension, the government will add an extra £25. If you’re a higher- or additional-rate taxpayer, you can claim additional relief through your tax return.
As well as an immediate 20% return on your savings, pensions can also offer good long-term growth potential, aligned with your personal tolerance for risk. Crucially, by paying into a pension it also means you build up a fund of money to use in retirement that has nothing to do with the eventual sale of your business. If you have a substantial pension pot when you retire, it means you may not be reliant on the disposal of your business to fund your lifestyle.
As well as paying into a pension, if you’re a business owner you should also consider putting any cash you have tied up in your company into an investment portfolio. This will generate returns over a longer period and enable your money to work hard for you for when you need it in later life.
If you’re used to taking a risk – as an entrepreneur, it might be second nature to you! – then you may wish to consider investments such as Venture Capital Trusts (VCT) or putting money into an Enterprise Investment Scheme (EIS).
Note that VCT investments come with increased risk, which means they should be only part of an investment mix. It’s also important to view EIS as a medium to long-term investment, and it won’t be suitable for everyone. Always speak to your tax and financial adviser before investing.
Even if you prefer to take a more safety-first approach, there are potential tax disadvantages of merely leaving money sitting in your business.
Capital Gains Tax and Income Tax are both low at the moment, so not taking money out of the business could cost you more in tax in the long run if rates were to rise – a likely scenario given the cost of providing coronavirus support in 2020.
Plan a long time ahead
One of the most common assumptions a lot of business owners make is that selling their company will eventually provide them with all the security they need for their retirement years.
While this may well be correct, the truth is that it takes a significant amount of planning. There are a couple of risks that many business owners fail to consider:
- Their business could become obsolete due to market changes. The amount you expect to receive for your business may not materialise in twenty years’ time
- Governments could reform taxes. For example, the Chancellor has already made changes to Business Asset Disposal Relief (formerly Entrepreneurs’ Relief). Tax rates could rise or, worse, schemes could be reformed or scrapped before you come to sell your company.
Planning well in advance of a business sale often means taking money out of your business as soon as possible. Instead of leaving money in the company, we’ve seen above that investing it into pensions and a diversified range of assets can be beneficial.
An important first step here is efficient cashflow and budget planning in order that you can keep your personal and business finances separate. While this isn’t always easy, especially for smaller companies or those in the early stages of their growth cycle, it is an important part of a plan.
If you leave the planning until the last minute, it can be more difficult to extract the value from your business. Additionally, with life expectancy rates continually on the rise, the amount you have may not last you through your retirement. Finding out that you have to live on, for example, half your income will change your entire thinking and it may be too late to do anything about it.
Get in touch
If you’re a business owner looking for expert financial planning advice, please get in touch. Email firstname.lastname@example.org or call us on 01454 416653.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.