How Much Should I Save Into a Pension?

Phil Hendry02/12/2020

I want to grow my business, but also want to think about the future, how much should I put into my pension  – 4 key thoughts that will guide you:

 

Ok….we get it….it’s not exactly the most exciting subject, saving into a pension.  No doubt there are far more exciting things you would like to do with your money, but we do need to think about the future and the lifestyle we want.  That does require saving, and a pension is one of the most efficient routes you could go down.  There are very generous tax reliefs when putting money into a pension, AND, any growth while invested in your pension is free of tax….while it remains in there.  You will however pay income tax on a proportion of what you draw from your pension, when that day comes

There have always been slightly odd rules of thumb when it comes to how much you should contribute, such as….if you are starting to save into a pension, take your age, divide it in half, and this provides the percentage of income you need to save each year (i.e. if you started saving at age 30 and earn £50,000 p.a., save 15% of your income into a pension each year, £7,500 p.a.).  These aren’t all bad if they encourage people to save in the first place, which is often the hardest part, but hardly a one size fits all.  This disregards any number of variables very personal to each of us, such as the lifestyle we want when we stop working, helping children, other assets you have, special trips organised, regular car purchases….the list goes on.

As a business owner, add in the complication of focusing on your business, the unknowns related to this, and planning ahead…..and you might never get round to it!  There are some important factors we think will help guide you in making a start:

Do you have shorter Term Life Events / Transitions / Goals to fund?

 
We all tend to start businesses for different reasons, but one common goal is obviously to support our lifestyle now.  This means we need to generate enough cash / profits to take from our businesses to fund things such as buying houses, funding schools fees  holidays etc. …. and we all know our lifestyles gradually creep forward with our income!

These things may take priority over saving for the future.  The clearer you are on planning ahead for these goals you aspire to in the nearer term (i.e. pre retirement), the more  precise you can be in extracting what you need from the business, as well as the most tax efficient way to do it.

With some clarity on this, you will begin to understand how much of your profit is genuinely surplus, and therefore could be used for long term goals.

Do you need to retain money in your business to grow it?

 
If that is the case, and the growth you can achieve by redeploying your money in your business outweighs things like tax relief, a pension contribution might not be very attractive!  The tax saved may pale in comparison to the returns possible by reinvesting into your business, for future growth.
This may not be the case however, depending on your business, and the type of business you want to build.  You may have built a business that you do not want to expand, but rather maximise profitability by building a small efficient team.  In this case, passed using cash to build that team or the quality of your offering / product, further reinvestment for scale is not really relevant.

Next consideration is then how to take excess profits out of your business, and if you have met you short term needs as discussed in the point above, you can think much longer term i.e. when you are no longer running your business…and where your income is going to come from!

So if you are at this point, track your profit and loss. Over and above your short term income needs, extracting excess profits as pension contributions builds financial independence from the business, and reduces taxation (corporation tax if you trade through a limited company, or your self-assessment if a sole trader, partnership or LLP) in the same breathe.

Are you going to exit your business for a lump sum?

 
If you are a business owner, you need to think seriously about how you will eventually have an income if you are no longer running your business.  Are you going to exit your business at some point, or is your business unlikely to ever sell without you in it?  Is it possible you could exit, but not where you can live solely off the proceeds.

As we are always stressing, be intentional, and build your business with clear goals in mind.  This allows you to understand if you need to gradually extract money from you company efficiently, to remove reliance on an exit event (i.e. big lump of cash!).  Not all businesses sell, especially when it is heavily reliant on one particular individual, and if that’s the case, you essentially have to create your own exit through other savings.

If you have already used this as a tactic for profit extraction, have you hit your limits?

 
If you have made the most of the tax efficiency of a pension already, you may be confronted by the limit you can build up in pensions over your lifetime, called the Lifetime Allowance , which is currently £1,073,100 (2020/21).  Any value built up over this limit will attract a tax charge when accessing your pension.  There are circumstances where you may have been able to protect your Lifetime Allowance from changes applied in previous tax years, so it is possible it is higher than the current allowance.

Or you may be limited by how much you can contribute to a pension and still benefit from the tax efficiency.

When you think about things like investment growth on your pension as well, you may  need to be wary of these issues sooner than you think?  In that case, alternatives need to be considered.  They aren’t quite as efficient as pensions, but they are out there!

Now these shouldn’t necessarily be worked through in this order in every case.  For example, it might be clear that your business will never sell.  Understanding this will trigger thoughts about trade-offs, over short term ‘nice to have’s’, or prudently setting aside money for the long term.  The order does however provide a good starting point.

Importantly, without these considerations, more often than not pensions are disregarded or deferred as an option.  But it’s not a binary call….”pension or not”….with enough thought, it can form at least part of your strategy.  To create the future you would like, where you focus on lifestyle, and only work because you want to…not because you have to.