A pension ensures you can fund the retirement you want, and it’s also a tax-efficient way to extract profits from your business.
If you have just started a business and are trying to win your first clients, secure financing or find office space, it can be difficult to think beyond the next month, let alone several decades into the future.
Yet making decisions for the long term is important, especially when it comes to pension contributions. Not only is saving for retirement a sensible strategy for any entrepreneur, but it’s also an extremely tax-efficient way of extracting profits from your business.
“You’re getting maximum bang for your buck,” says Claire Trott, Divisional Director – Retirement and Holistic Planning at St. James’s Place Wealth Management. “It’s an allowable business expense, so it reduces your profits for Corporation Tax and is not subject to employer’s or employee National Insurance.”
Many entrepreneurs don’t realise how straightforward it is to begin saving into a pension. In this article, we will take you through some of your options and demonstrate how pension savings can be a smart, tax-efficient way to take capital from your business.
How do you set up a pension?
If you’re a limited-company director, it’s as simple as choosing a personal pension and following the steps to set it up. You could save with a recognised provider, who will offer you a range of funds to choose from, or via a Self-Invested Personal Pension (SIPP), where you have wider investment options which you can manage yourself or use a professional such as a fund manager to do for you. Alternatively, you could set up a company pension scheme.
After making your choice, the most important thing to do as a limited-company director is ensure the pension contributions are made through the company. If you pay yourself a salary and then make contributions from that, it’s subject to both employer and employee National Insurance, thus reducing the amount you can save into your pension. It is worth noting, however, that as soon as the company hires an employee, an auto-enrolment pension must be set up. Failure to do so can result in fines.
What are the tax benefits?
The table below shows the advantages of using business profits to save into a pension compared with paying yourself a salary or paying yourself through dividends. All assume the company has £20,000 to distribute and that the dividend allowance has already been used.
Based on 2021/2022 tax year
What are the annual limits for saving into a pension?
The annual allowance for paying into your pension pot before having to pay tax is £40,000. In some circumstances, you can carry over unused allowances from up to three years previously. If you’re a high earner with a threshold income of more than £200,000 and an adjusted income of more than £240,000, your annual allowance is reduced (known as the tapered annual allowance). Ask your St. James’s Place Partner for details
What are the risks?
Although it is the most tax-efficient way of extracting profits, pension savings cannot be accessed until you are 55 (increasing to 57 from 2028), and therefore do not help with personal finances before then. Many entrepreneurs choose to diversify the distribution of their profits between salary, dividend and pension contributions. Taking advice from a professional at St. James’s Place can help you strike the right balance here.
Can my business be my pension?
Many entrepreneurs do not save into a pension because they think selling their business will be sufficient to fund their retirement. While this can work, unforeseen circumstances can mean the company does not perform as expected, reducing your income in later in life. There are also significant tax charges to consider when selling a business.
Trott says: “It is very risky because you don’t know what’s going to happen in the market between now and the moment you retire. The business you’re running, although you may think it’s future-proofed, may not be. Just because you’re really good at your business, it doesn’t mean someone will be ready to take it over or willing to give you the money you think it’s worth.”
Take advice
“It’s really important to take advice,” says Trott. “I’d urge people to have two advisers – a financial adviser, who will talk about your limits and what you put into your pension. But you’ve got to involve your accountant as well, because what you don’t want to be doing is putting money in that doesn’t get Corporation Tax relief.”
Speak to a St. James’s Place Partner to determine what might be the best option for you and your business.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief is generally dependent on individual circumstances.
The flexibility of a SIPP allows you to spread the risk, especially if some investments perform badly. However, these do tend to have higher costs than a standard pension and active management is essential to maximise the benefits of the wider investment choice on offer. For these reasons, they will not be suitable for everybody and generally only those who are fairly experienced at actively managing their investment should consider this type of investment.