My Business is my Pension
When we ask business owners how they plan to fund their retirement, we are regularly told that “my business is my pension”.
This may be an assumption you have made, however if you are working in a family business this is not always an option.
I recently watched an informative webinar from a National accountancy firm on how family businesses can extract value from their business.
As someone who regularly works with family businesses it is obviously important to keep my knowledge up to date and also see if there were any new pearls of wisdom to assist the businesses we work with.
Having got to the end of the presentation I have to admit, I was a little disappointed. Not in the content that was within the presentation, as this was very comprehensive. I was more disappointed with a really simple way that businesses can extract value that was not mentioned once.
Now it is not fair to ‘blame’ the accountancy firm for this and so the purpose of this blog is to complement their ideas rather than criticise them.
So this post will look at how to extract value from your business progressively, tax-efficiently and in a way that could help you to achieve financial independence from your business.
This is through contributions to a pension plan.
“But my Business is my Pension”
If we had a quid for every time that we heard “my business is my pension” from business owners, we could retire ourselves! It is not necessarily a bad idea, if it is a source of wealth whilst you are working, it is understandable that you may expect that it will continue to fund your retirement, however this may not always be possible.
If you are hoping to pass the business on to future generations, simply selling your business when you want to retire may not allow you to pass the business on.
One way for you to ensure that my business is my pension is very simply to make pension contributions.
I would say that, wouldn’t I, I have a vested interest. but let’s look at the reasons why this may be a good idea.
Let’s assume that your business is doing well and has some spare cash. You have the option of paying yourself a salary, a dividend or paying your future self in the form of a pension contribution. There is tax and N.I. on the salary payment, tax on the dividend payment but tax relief on the pension contribution.
This ignores the option of any reinvestment into the business, and this of course is a possibility, you may even argue that this would enhance the value of the business for any future sale.
If this is the case you are then relying on a single asset to provide you with your retirement income and the business cannot be passed down to the next generation without them having to find a load of cash to buy the business.
Making pension contributions over a prolonged period can lead to a gradual extraction of value from the business, without putting a big strain on the finances.
Once the money has been placed within a pension arrangement it is able to grow tax free, it is not guaranteed to grow but over time, assuming you put in place a well-diversified mix of investments, you could reasonably expect it to.
When you come to drawing your money out of the pension, under current legislation, 25% of this can be withdrawn free of tax.
After that you have complete flexibility over how you then draw your remaining income, allowing you the opportunity to maximise the tax efficiency of this.
In the event of your death, the funds can be passed on to your family, completely tax free if you die before 75 and at their marginal rate of tax if you are over 75.
This can allow for multi-generational pension planning. Passing wealth to the next generation, again independent of the family business.
Another clear advantage of using pensions as a means of extracting value from the business is that it can contribute to you achieving financial independence from the business.
As mentioned earlier there are a large number of business owners who see the success of their retirements linked solely to the sale of their businesses.
Extracting value in this way allows you to build significant wealth away from the business meaning that any future transition, be that a sale or passing the business on to the next generation, does not have to carry the same pressure.
If you are able to pass the business on without the necessity of raising serious money, it makes that transition so much easier.
Have a plan
Again, we are slightly biased here, but we would recommend that you have a plan. Not just a business plan, or a succession plan, but also a personal financial plan that can guide you in understanding ‘how much is enough?’
How much do you need to extract from the business to allow you to live the lifestyle you want in retirement, without the fear of running out of money?
This form of ‘Parallel Planning’ can help to remove the need for a capital sum at retirement and rather than saying “my business is my pension” you will be able to say “my business funded my retirement”
Being in control of your financial future will assist in implementing a successful succession plan. It removes your financial reliance on the business and can also help with the emotional separation from the business.
There are obviously some traditional methods for extracting value from your business. Making it as efficient as possible, making it dependent on processes rather than people, having robust corporate governance, all of these will make the business more attractive and therefore valuable to any potential buyer.
But, you are also able to extract value from the business in a non-traditional way such as a pension funding strategy.
A combination of both is likely to be the best outcome. It is important that your advisers are working collaboratively and coherently.
Most importantly is to have a plan and to continue to review it.