From now on anyone over the age of 55 can use accumulated pension funds in any way they wish, including taking their entire pension pot in a single lump. While this presents an understandable temptation to business owners looking for funding to support or grow their companies, the practicalities may make this less attractive than it first appears.
What remains unchanged under the new rules is that only 25 per cent 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 per cent rate or indeed 45 per cent for the highest earners.
As with any funding option, there are also influencing factors beyond the pensions themselves: retirement and exit planning, the business’ overall tax position, or existing involvement with other finance providers.
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. Here are four.
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 per cent tax-free allowance is taken in one go from the total £117,000 pot)
- £17,550 (the remaining £29,250 minus a 40 per cent higher tax rate deduction. This will vary depending on the director/owners’ individual marginal rate of tax)
- Making the total available for a director’s loan into the business: £46,800
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 per cent 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.
Read more on the pension changes:
- Pension changes open floodgates for possible savings splurge
- People should be trusted to make their own financial decisions
- New pension rules mean pots could be spent on being an entrepreneur
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. However, pension fund providers are already warning that access to funds in this way may not be available when the new laws go live.
SIPPs and SSASs
For owners or directors with accumulated pension funds greater than £50,000, a SSAS or SIPP can open the way to pension-led funding. 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/SSAS directly back to the pension fund. Repayment interest is usually set at around 10 per cent 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.
Business owners and/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.
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