We often get phone calls from people wanting to use their pension to help start a business, or indeed plough money into an existing business, which is often facing financial difficulties.
In fact, we’ve seen an increase in the number of enquiries of this nature, partly we believe due to Pension Freedom, which gives people over the age of 55 greater access to their pension. It’s also possible that wider knowledge of self-invested pensions has a part to play too.
In our view, using your pension to fund your business, whether it’s a new start up or an existing enterprise, is often an extremely dangerous thing to do, here are three reasons why.
#1: You probably need every penny you have to fund your retirement
Most people don’t have enough money in their pensions to fund a comfortable retirement, until they are very close to stopping work. In reality, many people never save enough money to fund their ideal lifestyle in retirement.
Over half of all small business in the UK fail within the first five years (Source: Telegraph), which means, in laymans terms, they go bankrupt. Of course you may buck that trend and become the next Richard Branson, we hope you do, but if you don’t and your business fails, what has happened to the investment you made from your pension?
That’s right, it’s all been lost, cutting your income in retirement.
If you are thinking of starting a small business as small business owners ourselves we applaud you, but don’t use your pension pot to do it, that should be there as a back up if things don’t go as well as you had hoped.
#2: It’s a very expensive way of funding your business
If you are over 55 you can now get unlimited access to your pension. However, if you do use this new found freedom to fund your business it could be extremely expensive.
You can take up to 25% of your pension pot as a tax-free lump sum, however any additional withdrawals are added to your other income and taxed at a rate of 20%, 40% or even 45%.
For some people taking large amounts out that could mean a hefty tax bill.
With interest rates so low and a larger than ever range of potential lenders, it may well be cheaper to borrow the money. The interest you pay may well be lower than the tax bill for taking money from your pension.
#3: Don’t get tempted if you are under 55
You can only take money out of your pension pot when you reach 55. Despite this rule being made very clear by HMRC there are some unscrupulous individuals, often masquerading as financial advisers, promoting schemes which claim to be able to get around these rules.
Don’t be fooled, these schemes are scams, which are likely to see you land up in hot water with HMRC and potentially facing a large tax bill.
If you are under 55, and speak to someone who tells you they can help you take money from your pension, simply walk away.
Of course there are exceptions
It’s the exception that proves the rule and there are possibly two we can think of.
The first, which we have seen on a number of occasions, is the use of a self-invested pension, either a SIPP (Self-Invested Personal Pension) or a SSAS (Small Self-Administered Scheme) to buy a property from which a business will trade.
This tends to be appropriate (although not always) for an existing business, which has a successful track record of trading and no longer wishes to pay rent to a landlord. Typically, those people who buy a commercial property in a SIPP or a SSAS have a larger pension pot, even if they top it up with a bank loan or lump sum contributions, which qualify for tax-relief.
Of course this route isn’t without risks, it can reduce diversification and mean too much capital is invested in one asset class, i.e. commercial property, and there is always the possibility that the business could fail thereby reducing the value of the pension fund’s investment.
However, we have seen this arrangement be successful, for the right individual, who takes and equally importantly, listens to, the professional advice they are given.
Secondly, there is also the rare circumstance where an individual has already accumulated sufficient assets to meet their needs in retirement and can therefore afford to take more risk with some of the money held in their pension.
This might be the case where an individual has built up a large number of years service in a final salary / defined benefit pension, which when added to their state pension, will be enough to live on in retirement. But, who also has an additional pension pot which is perhaps relatively insignificant.
In this circumstance careful planning is required to ensure that the individual does definitely have enough income in retirement, both now and in the future, having fully factored in such things as inflation and large capital expenditure which may be necessary.
Again, professional advice is vital.
Here to help
If you are thinking of starting a business and considering using your pension, we are here to help you decide if that really is the right course of action.
Call Sarah or Bev today on 0115 933 8433 or email firstname.lastname@example.org