Pension planning can be a crucial part of ensuring a secure and comfortable retirement. The sooner you invest in a pension the more you will have available to make the most of your retirement.
As a business owner, pension planning should be part of your overall planning for how best to finance your business and how to eventually realise the value you have built up in it. Separately, you will need to plan to meet your obligations to provide pensions for your employees.
1. Why act now?
Rising life expectancy has put pressure on retirement planning, highlighting the real danger that you might outlive your savings. By taking action early on, there is a greater chance you will be able to adequately fund retirement.
Decide how much you need to save to live comfortably in retirement
- Identify your ideal annual retirement income and work out what you need to save to achieve that.
- Allow for inflation when working out targets.
- Take advice (see Retirement planning).
The earlier you start, the less expensive it is to save
- A 50-year-old who starts saving for their retirement at the same time as a 40-year-old may need to save three times as much every month to secure the same level of pension saving.
2. How to fund your retirement
Since the advent of simpler rules on pensions and tax, business owners can make much more of their pension arrangements.
Company owners can use the pension fund to help finance the business
- You can do this by setting up a Small Self-administered Scheme (SSAS). SSASs fall under the same tax regime as other registered schemes and offer the same advantageous tax breaks.
- Employer contributions are unlimited and deductible against corporation tax.
- SSASs can hold up to 5% of its assets in the sponsoring employer's shares.
- An SSAS can lend money to the employer provided the loan does not exceed 50% of the net value of the scheme's assets.
- SSASs can borrow to invest or to pay a member's benefits. But borrowings must not exceed 50% of the scheme's assets.
Pension funds can now form part of an exit strategy for business owners
- If you plan to sell your business to fund your retirement, paying large contributions into your scheme will both provide a pension and reduce the capital gains tax on sale of the company.
- However, you cannot exceed the lifetime allowance without incurring a tax penalty.
A pension mortgage is a tax-efficient way of repaying a loan on a property
- You make interest-only payments on the mortgage while at the same time paying into a pension. At the end of the mortgage term, you use the tax-free lump sum from the pension to pay off the mortgage.
Pensions and tax
There are limits to the amounts you can invest in a pension through your lifetime:
- The annual allowance for individual contributions is £40,000. Contributions in excess of the allowance are subject to tax.
- An individual's lifetime allowance for pension savings is £1.03 million (£1,055,000 2019/20).
- The total value in all registered schemes will be tested at the time benefits are taken or at age 75. Any excess above the lifetime allowance will be subject to a charge of 25% if used to increase pension payments or 55% if taken as a lump sum.
- Benefits may normally be drawn after age 55. Members do not have to retire or leave service to take pension benefits.
- You can usually take a tax-free lump sum of up to 25% of the fund. You can withdraw larger sums but income tax is payable on any excess.
- You can still choose to buy an annuity to provide a regular income but are not required to do so. The level of annuity income depends on prevailing interest rates.
- You can also invest in a ‘flexi-access drawdown' fund. This leaves your savings invested and allows you to draw a more flexible income, but without a guaranteed lifetime income.
- Savings left in your pension fund when you die can be passed on in your will.
- Pension fund members should take advice and shop around to find the best option.
3. Forms of pension funding
Executive Pension Plans (EPPs) are contribution plans provided by the employer
- The plan is run by a life assurance company
- Employees are not liable to income tax or National Insurance contributions (NICs) on payments made to an EPP.
- Contributions are subject to tax relief limitations.
- Members can transfer existing plans into their EPP.
- The frequency and amounts payable to an EPP are usually flexible.
Self-invested Personal Pensions (SIPPs) are similar to standard personal pensions
- SIPPs are governed by the same tax, contribution and eligibility rules as personal pensions.
- SIPPS allow greater investment freedom. SIPP investors can control their investment strategy and hire a fund manager or broker to carry out investment decisions.
- SIPPs are run under trust law although the member can be the trustee if the plan is overseen by an independent administrator.
- Administration costs can be high.
Pensions Salary Sacrifice allows employees to exchange earnings for non-cash benefits
- Both employer and employee make NI savings.
- Employee pension contributions are converted into employer contributions which do not incur NI.
- The employer can pass NI savings to employees as a bonus contribution to the plan.
Some special schemes for high earners have become less relevant
- Funded Unapproved Retirement Benefit Schemes (FURBS)/Employer-Financed Retirement Benefits Scheme (EFRBS) were set up to provide benefits for employees earning more than the salary cap.
- Now that tax reforms have replaced maximum salary with a lifetime allowance, these schemes are less likely to be a suitable choice.
Types of occupational scheme
Defined benefit schemes (DB or final salary schemes)
- DB schemes place the responsibility for funding pensions on the employer.
- They promise a pension related to earnings at retirement.
- Employees can hope to retire on two-thirds of final salary, though most will retire on considerably less.
- The schemes are revalued to ensure they still have enough assets to pay pensions far into the future. Asset values are affected by certain factors, particularly stock market performance.
- Market volatility, increasing life expectancy and escalating costs have seen private corporate DB schemes disappear as the main form of occupational scheme in the UK.
Defined contribution schemes (DC or money-purchase schemes)
- DC schemes place the risk of underfunding on the employee.
- Employees are usually expected to select their own investment strategy for the scheme.
- Most schemes offer a default which most employees invest in.
- At retirement, the pension fund can be used to provide a lump sum and/or income.
- The size of the pension fund will depend on how investments have performed.
Hybrids/Risk Sharing Schemes
- These are neither pure DB nor pure DC and allow for risk sharing between employer and employee.
- Hybrid schemes include career-average plans and cash balance plans. Seen as a compromise between DB and DC, hybrids are gaining a place in occupational pension provision but remain the exception rather than the norm.
4. Options for retirement financing
Pensions may be the most tax-efficient way to pay for your retirement but they are not the only option.
Selling property at retirement offers a possible lump sum that could be used as a pension
- Using property as a pension means you can access the money before normal retirement age.
- You have more control over the asset.
- You are reliant on favourable property prices and the ability to sell the property when you want to retire.
Individual savings accounts (ISAs)
- All withdrawals from an ISA are tax free.
- Money can be accessed at any time.
- ISAs could be beneficial for basic rate taxpayers, but higher rate taxpayers are likely to be better off in a pension.
- The annual ISA limit is currently £20,000. There is also a Lifetime ISA for adults aged under 40. Up to £4,000 can be saved each year and the Government will add an additional 25% bonus.
5. Retirement planning
Choosing the right time to retire is often determined by how you have funded your pension
- If you are a member of a final salary scheme, your only options are to take a tax-free lump sum and an income. The income is guaranteed until you die.
- Defined contribution members can take a tax-free cash sum, usually up to 25% of the total fund, together with an annuity or flexible income drawdown (or both). You may be able to take more than this in certain limited circumstances.
- The new rules make it possible to claim a pension but continue to work.
- If you are selling the business to pay for your retirement, seek professional advice on the exit strategy.
Getting the best out of your pension requires professional advice
- Make sure your adviser is experienced in advising on the specifics of pensions for business owners.
- Check that your professional adviser is regulated.
- As well as taking advice on setting up any savings or pension plans, advice can be particularly valuable as you reach retirement or before selling your business.
- Get free guidance on pensions from the Pensions Advisory Service (0300 123 1047).
- Get free guidance on taking your defined contribution pension from Pension Wise (0800 138 3944).
- Get information on employers' pension obligations from the Pensions Regulator (0345 600 1011).
- Find guidance on running a pension scheme from HM Revenue & Customs.
- Find an independent financial adviser for your business through unbiased.co.uk.
- Check a financial adviser's authorisation by searching the Financial Services Register.