It has been estimated that £2bn will be withdrawn from personal pensions by 2020 - by business owners using pension freedoms to fund their business. If you are planning to use your pension to fund your business now might be a good time to evaluate your options.
Last month, the Forum of Private Business warned that more and more entrepreneurs are considering using their pension for growth capital, but have considered neither the tax implications nor the impact on their old age if the company fails.
'People think, 'Oh, it's only my pension',' said Forum managing director Ian Cass.
The Forum is right to alert small business owners to the tax implications of using their pension to fund their business, as the devil really is in the detail and a lot has changed since pension freedoms were introduced in April 2015. Unfortunately, there is also a general lack of knowledge, with more than two-thirds of people over the age of 55 not fully understanding pension freedoms.
Essentially, anyone over the age of 55 can now use their accumulated pension funds in any way they wish, including taking their entire pension pot in a single lump sum. But while this presents an understandable temptation to business owners looking for funding to support or grow their companies the practicalities make this less attractive than it first appears.
For those that need a small amount of funding - perhaps a few thousand pounds - the new rules can be advantageous. However, for those business owners that needed significant funding, in many cases, this could result in a potentially significant tax charge.
This is because the one thing that has remained unchanged under the new rules is that only 25% of an accumulated, untouched, pension fund is available tax-free. Any further withdrawals are subject to income tax in the year they are taken. For most business directors, that is likely to mean tax at the higher 40% rate or indeed 45% of the highest earners.
There are also influencing factors beyond the pensions themselves: retirement and exit planning, the business' overall tax position and existing involvement with other finance providers. So there are a number of possible options to consider and the best way to illustrate them is by taking an average business.
Based on Clifton Asset Management's client base of more than 2,000 businesses, the average SME director has £117,000 in accumulated pensions. That creates a number of possible options worth considering.
There is still the same drawback as the full lump. The first 25% is tax free, with the rest subject to income tax whenever it is taken - although this can be influenced by the timing of the sums being taken in the same, or two or more tax years.
There is also the likelihood of incurring multiple transaction arrangement charges for each withdrawal and a potential loss in performance of investments.
Under professional advice, owners can decide where pension funds are invested. Subject to fund size, there is no minimum age for the funds being accessed. However, the scale of this funding model requires a pension pot with a level of maturity that can support the transaction.
The loan made by the pension fund to the business is tax free, with the business repaying the capital and interest taken from the SIPP or SSAS plan directly back to the pension fund. Repayment interest is usually set at around 10% or more, offering significant pension fund growth potential. The owners can even access the scheme again for further funding subject, amongst other factors, to the repayments being met.
In stark contrast to those business owners that are exercising the new freedoms without advice, the PLF process relies upon a rigorous evaluation of the business and its business plan before any pension investment is recommended. This rigor has meant that 97% of business owners who used PLF are still in business after five years (compared to just 50% of businesses in general).
Before you make any decision on putting your nest egg into your business, it is time to consider your options, as your choice could not only help your business blossom, but it's also likely to improve your long-term tax planning.
Last month, the Forum of Private Business warned that more and more entrepreneurs are considering using their pension for growth capital, but have considered neither the tax implications nor the impact on their old age if the company fails.
'People think, 'Oh, it's only my pension',' said Forum managing director Ian Cass.
The Forum is right to alert small business owners to the tax implications of using their pension to fund their business, as the devil really is in the detail and a lot has changed since pension freedoms were introduced in April 2015. Unfortunately, there is also a general lack of knowledge, with more than two-thirds of people over the age of 55 not fully understanding pension freedoms.
Essentially, anyone over the age of 55 can now use their accumulated pension funds in any way they wish, including taking their entire pension pot in a single lump sum. But while this presents an understandable temptation to business owners looking for funding to support or grow their companies the practicalities make this less attractive than it first appears.
For those that need a small amount of funding - perhaps a few thousand pounds - the new rules can be advantageous. However, for those business owners that needed significant funding, in many cases, this could result in a potentially significant tax charge.
This is because the one thing that has remained unchanged under the new rules is that only 25% of an accumulated, untouched, pension fund is available tax-free. Any further withdrawals are subject to income tax in the year they are taken. For most business directors, that is likely to mean tax at the higher 40% rate or indeed 45% of the highest earners.
There are also influencing factors beyond the pensions themselves: retirement and exit planning, the business' overall tax position and existing involvement with other finance providers. So there are a number of possible options to consider and the best way to illustrate them is by taking an average business.
Based on Clifton Asset Management's client base of more than 2,000 businesses, the average SME director has £117,000 in accumulated pensions. That creates a number of possible options worth considering.
Four options for investing
1. Single lump
Let's suggest a business requires £58,500 (half of an average accumulated business owner's pension pot). Under pension freedom, allowing for tax, the outcome is:- £29,250 (if the full 25% tax-free allowance is taken in one go from the total £117,000 pot)
- £17,250 (the remaining £28,750 minus a 40% higher tax rate deduction. This will vary depending on the director or owners' individual marginal rate of tax)
- Making the total available for a director's loan into the business: £46,500
2. Multiple lumps
This option applies if a business needs a total investment of, say, £30,000, but an immediate requirement £10,000, with the remainder at a later stage.There is still the same drawback as the full lump. The first 25% is tax free, with the rest subject to income tax whenever it is taken - although this can be influenced by the timing of the sums being taken in the same, or two or more tax years.
There is also the likelihood of incurring multiple transaction arrangement charges for each withdrawal and a potential loss in performance of investments.
3. Small sums
Where small capital sums or cashflow boosts are needed, pension freedom can allow the release of a few thousand pounds at a time. This still attracts income tax, but is more attractive for business owners with income closer to a higher bracket.4. SIPPs and SSASs (pension-led funding)
For owners or directors with accumulated pension funds greater than £50,000, a Small Self Administered Scheme (SSAS) or Self-Invested Personal Pension (SIPP) can open the way to Pension-led funding (PLF).Under professional advice, owners can decide where pension funds are invested. Subject to fund size, there is no minimum age for the funds being accessed. However, the scale of this funding model requires a pension pot with a level of maturity that can support the transaction.
The loan made by the pension fund to the business is tax free, with the business repaying the capital and interest taken from the SIPP or SSAS plan directly back to the pension fund. Repayment interest is usually set at around 10% or more, offering significant pension fund growth potential. The owners can even access the scheme again for further funding subject, amongst other factors, to the repayments being met.
In stark contrast to those business owners that are exercising the new freedoms without advice, the PLF process relies upon a rigorous evaluation of the business and its business plan before any pension investment is recommended. This rigor has meant that 97% of business owners who used PLF are still in business after five years (compared to just 50% of businesses in general).
A considered approach
Business owners or directors need to consider their options and take expert advice if they want to benefit from pension freedom. However, a considered approach could certainly see pension pots being put to work effectively to back their business.Before you make any decision on putting your nest egg into your business, it is time to consider your options, as your choice could not only help your business blossom, but it's also likely to improve your long-term tax planning.
