Family run businesses are the bedrock of the now firmly expanding British economy. Business owners, many of them husbands and wives, have worked together for years to build fledgling enterprises into profitable businesses, and rightly deserve rewarding retirement years. The saving and retirement culture in Britain has altered fundamentally in the last decade. The choices on offer are matched by potential challenges, especially for owner-directors and the family members they employ.
The purpose of this article is to discuss the options available to business owners looking to make the most of their working lives whilst also planning for the future.
Healthier Lifestyles Have a Cost Benefit
Since the inception of old age pensions a century ago, life expectancies have soared. Better diets, more leisure time, and greater prosperity combined with a decline in smoking and new medical changes mean that traditional ideas about pensions have been out of date for some time. Living longer into old age is of course the great achievement of our age, but now our financial plans need to catch up.
The Bonfire of the Annuities
The Chancellor, George Osborne, introduced the most fundamental change to the pensions market in decades at the last budget. By proposing to remove the restrictions on how much an individual can take from their pension pot with effect from April 2015, annuities may now be less attractive for many people. Previously, a majority of savers were effectively locked into using annuity policies, even if some of them were not appropriate for the savers needs. Alternatives for removing capital from your pension faced hefty tax penalties or required complex investment alternatives. Not having access to hard earned capital from a business, outside of the 25% tax free lump sum allowance, has put many business owners off fully funding their pension pot. The new rules allow individuals to take further residual funds out of their pension pot, therefore removing this concern and opening up genuine tax planning opportunities.
Adding a Lump Sum to a Pension Pot
As a simplified example, if your spouse has a paid role in your firm, the firm can often add contributions to their pension of up to £40,000 a year.
The immediate tax benefits are two fold. Firstly, the rules allow you to carry forward any unused annual allowance from the three previous tax years to offset this charge. Secondly, as the tax free benefit is a personal allowance, it means both partners can use their own allowance without incurring penalties.
Pension benefits can be taken at 55 in the form of a 25% tax free lump sum and further staged drawdowns in the future. If you or your spouse has no other earnings, you can take your £10,500 in the next tax year free of tax as well. On top of your personal tax benefit, the company can reduce its Corporate Tax liability by funding the pension contribution.
With Added Death Benefits
These new rules also open up the potential for enhanced death benefits. Currently once income (or drawdown) is taken there is a 55% tax charge on any amount left in the pot on death. However, from 2015 it’s easier to manage the way income is taken, so parts of the pot on death before 75 are free from the 55% tax rate. It is also widely anticipated that in the future, the 55% tax levy on death will reduce. It is not currently known what the new rate will be or how it will be calculated although one school of thought is that it may be based on an individual’s marginal tax rate.
Future Proofing Your Wealth
Taking a chunk of your pension from the pot in the form of income drawdown leaves the remainder of your pension fund invested in the favourable tax environment and allows you to draw a regular taxable income from this pot. But remember that the fund could fall as well as rise. You may have to pay set-up and annual charges on the investments in your fund; and if the income you take plus these charges exceed any growth in your fund, the value of your fund will decrease. Purchasing an annuity with the remainder of the pension pot can make sure that whatever happens on the stock market, that a guaranteed income will be available each month. Annuities always have a cost, as managed policies they attract charges, but in return they insure the purchaser against future economic volatility. Given the past twenty years of economic volatility, many retirees are now looking to future proof themselves.
You should review the new tax planning advantages of the pension reforms in the context of your finances as a whole. It’s prudent that if you are interested in seeing if the new pension rules can benefit you, to seek professional financial advice.