Can my business be my pension?

Can my business be my pension?

Can my business be my pension is a question we are often asked. Many business owners see their business and/or perhaps their business premises as their pension pot for retirement.

If you are hoping to use your business as your pension and fund your retirement solely from the sale of your business or its premises, then this can be a very risky strategy. Your business will always carry risks of something going wrong and losing value that you were relying on for your retirement.

Even if your business is doing well, an exit can be unpredictable from both a timing and profit perspective.

Your retirement planning should include other investments to diversify your portfolio, minimise risk and avoid having all your retirement income based on just proceeds of sale from your business.

Should you rely solely on your business as a retirement income source?

When you are starting out and growing a business, it is often the case that you forgo long-term pension planning and maximising personal wealth or personal pension contributions in order to reinvest money back into your business to grow it further.

This is totally understandable. However, there are still many business owners of established businesses that don't have enough money set aside in pensions or other investments to fund their retirement. Many business owners simply have the plan to sell their business when they retire and use the proceeds to fund their retirement long-term.

We so often hear owners that say, "My business is my pension". But there are many reasons why this shouldn't be your only plan!

Are there risks to relying on your business as your pension?

There are huge risks associated with relying solely on your business as your pension. Every business carries risk, whether it's from evolving markets, new competition, loss of a key customer, supply chain issues, changes in regulations or even a pandemic! No business is safe from these types of risks. Certainly, as a business owner, you can employ strategies to minimise some of these risks, but wider global and economic factors are completely out of your hands.

Even if your business performs well, when you come to sell or exit, there could be unpredictability in the final deal. This can be due to the market at the time, your company's profits, your timing and the number of potential prospective buyers.

We often see business owners overvalue their own businesses and base their retirement plans on what they consider their business value to be rather than what someone will be willing to pay for it. This can have a huge impact on your retirement pot and ongoing income, and you may not realise this until the last minute as the deal is being done.

Having all your retirement eggs in one basket i.e. your business, is very risky and is not an overall good retirement strategy.

What are the missed opportunities?

By using your business as your pension, you could be missing out on key tax planning opportunities around pension contributions and investments in other assets.

You can contribute to your pension either personally or by paying money directly from your limited company. Pension contributions can be used to reduce your overall tax liability either via pension tax relief or savings in corporation tax.

Personal pension contributions

With personal pension contributions, you only pay an amount that is net of basic rate tax as the government tops up your fund with the tax element. This means if you want to put £100 into your pension fund, you just pay £80, and the government contributes £20.

If you are a higher-rate taxpayer, the pension company claims back an amount equal to the basic rate tax on the pension contribution, but as a higher-rate taxpayer, you can also claim an additional 20% tax relief against your tax liability.

One downside of personal pension contributions is that you only get tax relief on contributions equal to your Net Relevant Earnings.

Net relevant earnings include salary but not dividends, therefore, business owners who take a small salary and large dividends will have a low pension relief limit. To make larger pension contributions, you could take a bigger salary or make the contribution straight from your company as an employer contribution.

Making pension contributions from your business

Employer pension contributions have two main benefits; the first is that there’s no employer's or employees’ national insurance to pay on the contribution. The second is that an employer contribution is not limited to your net relevant earnings.

In addition, the company can usually offset the pension contribution against its taxable profits and save on corporation tax. Employer contributions are, therefore a very tax-efficient way of extracting profits from your company and providing for your retirement.

Pension thresholds

There is no limit to what you can put into a pension during your lifetime, however, there is a limit on what you can contribute annually and receive tax relief on. This annual allowance is currently £60,000 gross per tax year.

If you don’t use your full annual allowance, you can carry it forward for up to three years if you have been a member of a pension scheme in any particular year for which you wish to carry forward.

If you are a high earner, you may only be entitled to a reduced annual allowance.  This is due to tapering rules when a person’s income exceeds £200,000 and can reduce your annual allowance down to as low as £4,000.

Is there tax relief on pension contributions?

You can get tax relief on private pension contributions worth up to 100% of your annual earnings.

You’ll either get the tax relief automatically, or you’ll have to claim it yourself. It depends on the type of pension scheme you’re in and the rate of Income Tax you pay.

If you make pension contributions directly from your limited company, these contributions can be deducted from the company’s profits before tax. So, not only will you save income tax by not taking the money out of post-taxed income, but you’ll also save the corporation tax as well.

Small self-administered scheme (SSAS) vs. Self-Invested Personal Pension (SIPP)

SSAS and SIPP pensions both give you influence over how your pension money is invested. The key difference is that Self-Invested Personal Pensions (SIPPs) give individuals control over their investments, whereas small self-administered schemes (SSAS) pensions are for company directors, senior staff and family members and are controlled by all trustees of the scheme. Therefore with a SIPP, the entire pension pot belongs to the owner of the SIPP, whereas with a SSAS there are no individual pots, instead, each share is defined by a percentage.

Investing in commercial property through pension schemes

Some business owners choose to buy their business property outright during the running of their business, and often they decide to retain the premises after they exit the business to generate rental income.

You need to carefully consider the premises and the option to sell the premises on retirement or if your premises will be part of any future business sale.

You can hold property in a separate holding company, which will allow you to minimise risk from any trading issues the business may face, can offer tax advantages, and also allows you to keep the property separate from the eventual sale of your trading business, thus allowing you to use any future rental and uplift in value in retirement.

You also have the option of owning a commercial property in a pension scheme. This can be both tax efficient and allow you to still receive rental income after exiting the business. Only SIPPs (Self Invested Personal Pensions) and SSASs (Small Self-Administered Schemes) can hold commercial property investments.

Conclusion

Some business owners decide to reinvest their profit back into their business and don't always put enough money aside outside of their business for their retirement. Many owners don't adequately diversify their investments in order to fund their retirement and end up relying on the value and sale of their business to fund their full retirement. Having all your eggs in one basket i.e. your business value, is a risky strategy. Business owners should proactively invest in a diversified portfolio, whether it be their business, property, stocks and shares or pensions. This can help to minimise risk in retirement.

As you prepare for retirement as a business owner, you need to make sure you can retire on your terms by planning ahead. Taking advice from tax experts, accountants, and financial advisors long before you retire will help you to build the right diversity of investments, minimise risk and maximise tax reliefs and savings prior to retirement.

If you'd like advice on retirement, exit planning, or tax planning, then contact our team in Chester, Liverpool, or Wirral.