Pension Saving

Phil Hendry02/12/2020

Pension Saving.
You want to grow your business.
But you’re also thinking about the future…

Here’s FOUR key thoughts that will guide you…

Ok, we get it.
It’s not exactly the most exciting subject, ‘pension saving’.
No doubt there are far more exciting things we could write about. Such as what you would like to do with your money, but we do need to think about the future and the future 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 don’t forget that any growth while invested in your pension is free of tax, whilst it remains in there.
You will, however, pay income tax on a proportion of what you draw from your pension, when that day comes…

Rules of Thumb

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.

pension

Maybe we’ll see a pensions dashboard in the near future…

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:

Pension Saving #1 – Do you have short-term lifestyle events or goals to fund?

Business owners all start their own businesses for a variety of reasons.
One common goal, though, is obviously to support their current lifestyle. This means they need to generate enough cash / profits to take from their business to fund things such as buying a house, funding schools fees or 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 (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.

Pension Saving #2- 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. Maybe your goal is to maximise profitability by building a small efficient team.
In this case, using cash to build that team or the quality of your offering / product, further reinvestment for scale is not really relevant.

The next consideration is then how to take excess profits out of your business.
If you have met your short term needs (as mentioned previously), you can think long 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.

Pension Saving #3 – Are you going to exit your business for a lump sum?

If you are a business owner, you need to think seriously about your 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 see if you need to gradually extract money from your 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.

Pension Saving #4 – Or 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 you’ve 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.