My business is my pension

Published: 25/04/2024 By Mackenzie Street

Business owners all too often overlook pension planning. The Institute for Fiscal Studies has found that private pension participation between the self-employed and the employed is alarmingly mismatched. Between 2018 and 2020, only 20% of the self-employed were contributing to a private pension. In comparison, 80% of the employed were contributing to a private pension during the same period. [1]

This significant mismatch is predominantly caused by two factors. One, business owners have more urgent priorities, such as keeping their business afloat; and two, auto-enrolment forces employees to save for retirement without them needing to opt into a workplace pension scheme.

Due to the existence of these two factors, the self-employed often lack sufficient private pension provision and adopt the mindset of “my business is my pension”. However, this strategy is fraught with risk:

  • Selling your business to provide funds for retirement may seem lucrative, but the exit strategy can be unpredictable. Economic fluctuations, industry trends, and market conditions can all significantly impact the final sale price. This means that business owners can never be certain on the size of their retirement fund until the sale has passed, thus preventing them from planning their finances pre-retirement.
  • Picking the right time to sell your business is crucial. If your strategy was to exit the business in say, 2019 or 2020, the COVID-19 pandemic was probably detrimental to your exit plan. You may have received an underwhelming final sale price for your business, or you may have decided to not proceed with the sale at all and delay your retirement.
  • Having all your retirement eggs in one basket is not a good retirement strategy. In the financial planning world, diversification is often mentioned as being the most important component to any investment strategy. It reduces your reliance on any one asset (your business) to perform by spreading your risk across many different investments.

Your pension is your pension
Making a pension contribution may allow you to benefit from tax relief. If a basic rate taxpayer wants to contribute £100 into their pension, they only need to physically pay £80 and the Government will top-up the contribution with the extra £20 in the form of tax relief. If this £80 was instead paid to this taxpayer as part of their wages, it would be taxed.

Pensions also benefit from tax efficient growth. Within the pension wrapper, your investments should not be subject to UK income tax or capital gains tax. This means that any interest or dividends you receive from your investments should not be taxed, and neither should any capital growth on those investments. This ultimately adds an extra boost to your retirement savings.

Defined contribution pensions can also be used as a legacy planning tool. On the death of the original pension member, any remaining pension funds can be passed on to their beneficiaries in the form of an inherited drawdown pension. This type of pension will allow:

  • Funds to remain in the pension scheme under an arrangement set up for the beneficiary.
  • The beneficiary to draw what they need from this pension at any time until the fund is exhausted.
  • The beneficiary to nominate who they would like to benefit from any remaining funds when they die, which allows for pension savings to pass down through generations.
If the pension member dies before age 75, lump sum death benefits can be paid to a beneficiary generally tax-free as long as payment is made within two-years of the pension scheme administrator learning about the member’s death. If the pension member dies after age 75, benefits are taxable at the beneficiary’s marginal rate of income tax.

Source [1]

This article does not constitute advice and only aims to provide basic information. If you would like to receive advice, you should contact our office on 020 8661 7878 and arrange a consultation with one of our financial advisers. All initial meetings are at our cost, so you can be safe in the knowledge that you will not receive an unexpected bill for our time.
Any reference to legislation and tax is based on tba Wealth Management’s understanding of United Kingdom law and HM Revenue & Customs practice at the date of production. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances.