This guide looks at the pension saving options available to business owners who are directors of their companies.
Planning for retirement
Running your own business takes time. Business owners can find themselves under daily pressures that mean important areas of financial planning end up neglected.
Planning and saving for retirement will be one of the more important decisions you make. As a business owner there are many options available to you when it comes to effective pension planning, many more than for employees.
But with more choice comes more tax rules, regulations and complexities, which is why it is important to speak to your financial adviser about your pension options.
Pensions and tax
While there are various ways to fund your retirement, a pension is one of the most tax efficient vehicles, thanks to generous tax relief and low tax on gains while invested. Standard tax relief is the basic rate of 20 per cent, but if you pay tax at the higher rate of 40 per cent or additional rate of 45 per cent you can claim up to those amounts in tax relief.
When you make a personal contribution to a pension, 20 per cent will be added automatically by the pension provider, to reflect the standard tax relief. But if you pay tax at the higher rates you can claim back up to a further 20 or 25 per cent through your tax return, depending on the level of tax you pay.
A top rate taxpayer pays tax at a rate of 45 per cent. When they contribute £8,000 into a pension it will be topped up to £10,000 automatically. They can then claim up to a further £2,500 through their tax return.
We would usually expect a Director who is a business owner to make pension contributions direct from the Company. Tax relief on employer contributions to a registered pension scheme is given by allowing contributions to be deducted as an expense in computing the profits of a trade, profession or investment business, and so reducing the amount of an employer’s taxable profit. Employer contributions will be deductible as an expense provided that they are incurred wholly and exclusively for the purposes of the employer’s trade or profession
There are limits to the amounts you can invest each year in order to receive tax relief, and there is also a limit on the total pension value you can accrue without attracting a tax charge.
For the 2013/14 tax year the lifetime allowance for pension savings is £1.5 million, but this reduces to £1.25 million on 6 April 2014.
You can save more than this into a pension but you may face a lifetime allowance charge on the excess. The way that this is charged depends on how the excess is taken. If you take it as a lump sum the charge is 55 per cent, if you take it as a pension the charge is 25 per cent.
There are ways to protect the lifetime allowance, which currently allow you to save up to £1.5 million without paying the lifetime allowance charge even after April 2014. These include Fixed Protection 2014, which will fix your lifetime allowance at £1.5 million without charge, provided no further contributions are made. Individual Protection will also be introduced from April 2014, allowing savers to protect their lifetime allowance at £1.5 million and still make contributions. Anything above £1.5 million will be subject to the lifetime allowance charge.
The annual allowance for individual contributions is currently £50,000 but this reduces to £40,000 in 2014/15, although you can carry forward any unused annual allowance from the three previous tax years.
As a business owner there are many pension options open to you. These include:
Small Self-Administered Scheme (SSAS)
As a company owner you can set up a SSAS, which is a type of occupational pension scheme. These schemes suit shareholding directors because they allow you to maintain control of your pension arrangements, with some flexibility and the usual tax relief associated with pensions.
As occupational pension schemes they must be established by an employer. The scheme is set up under trust and is a separate legal entity of which most members are usually trustees.
SSASs have the freedom to invest in a wide range of vehicles, including shares, gilts, unit trusts, deposits, commercial property and land and insurance company funds.
When it comes to shares, a SSAS can hold up to five per cent of the sponsoring employers’ shares.
The SSAS can also borrow funds from an individual, company or financial institution. If a scheme borrows more than 50 per cent of the value of the pension fund the scheme administrator will have to pay a 40 per cent scheme sanction charge on the amount above the limit.
As an occupational pension scheme a SSAS can lend money to the employer as long as the loan doesn’t exceed 50 per cent of the net value of the scheme’s assets. Other conditions apply, such as the loan not being for more than five years and the interest charged being at least one per cent above the average base lending rate of leading high street banks.
Self-Invested Personal Pension (SIPP)
A SIPP is a type of personal pension that allows you to decide where your money is invested. Unlike a SSAS, it is the SIPP provider that has overall control of the scheme, although the member makes decisions on investments.
SIPPs can invest in much the same as a SSAS, including stocks and shares, gilts, unit trusts, deposits, commercial property and land and insurance company funds. The main benefit of a SIPP is that it allows you the control to choose where your money is invested.
Like the SSAS, SIPPs can also borrow funds from an individual, company or financial institution. The amount borrowed must be less than 50 per cent of the scheme’s assets.
Because SIPPs are personal pensions as opposed to occupational schemes, they are unable to make loans in the same way as a SSAS. They can make loans to third parties provided they are not connected to a scheme member or employer. Broadly speaking ‘connected’ means relative, spouse or civil partner.
For many business owners, their business is their pension, which is why it is important to have an exit strategy in place.
If you plan to sell your business to fund your retirement it is important to have been a member of a pension scheme for the last three years to ensure you can carry unused annual allowances forward.
As the rules stand you may be able to carry forward any unused annual allowance from the previous three years. This effectively allows you to make one-off large contributions to your pension. Doing this can also reduce your capital gains tax liability, as a result of reducing the value of the business sale by some or all of the amount contributed.
Payment of pension benefits
You can generally draw pension benefits from the age of 55, although you may be able to draw earlier in some circumstances such as ill health.
How you take your pension is up to you, but you are able to take up to 25 per cent as a tax free lump sum and the rest as a pension. It is worth noting that you must not ‘recycle’ your lump sum by using it to pay contributions to a pension scheme, because if you do it will no longer be tax free.
Your options when you take your pension
When you take your pension you can decide how your pension is paid to you. The main options include:
Where your pension scheme pays your pension pot to an insurance company to buy an annuity contract. They will then pay your pension to you for the rest of your life.
This allows you to take income from your pension pot while it is still invested. You can choose how much you want to be paid each year, within certain limits.
Please contact us on 01509 410 364 to find out how we can help you to structure your director’s pension.
The way in which tax charges (or tax relief, as appropriate) are applied depends upon individual circumstances and may be subject to change in the future.
This document is solely for information purposes and nothing in this document is intended to constitute advice or a recommendation. You should not make any investment decisions based upon its content. The value of pensions can fall as well as rise and you may not get back the amount you originally invested.
Whilst considerable care has been taken to ensure that the information contained within this document is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information. Errors and omissions excepted.