When we first meet with business owners and Directors we often hear the refrain, “My business is my pension”.
But is this really true?
If you are successful in building a business and manage to sell it, then yes, your business could provide you with sufficient cash to retire on.
However, could this be a rather risky strategy? A problem that affects your business now or at the point of sale has a knock on effect to your retirement plans; this would not necessarily be the case had you made separate, independent, arrangements.
Remember, planning for retirement does not necessarily mean paying into a pension, it simply means having a plan that will one day allow you to have an independent source of income sufficient to maintain your lifestyle without having to work.
Everyone is different, so we thought we would take a look and compare some of the main advantages and disadvantages of relying on your business against making separate independent provision.
Relying on your business – Advantages
- No commitment to make contributions
- No investment risk involved
- Not massively affected by rise and fall of the stock market
- If you are the sole owner you can sell your business and access the capital anytime
- On sale of the business you may benefit from entrepreneurial relief resulting in a lower tax bill
- When you die you can pass the assets to whoever you want
- Often a feeling of being more in control and often more exciting than making a simple investment
- You won’t benefit from tax relief from on your contributions
- It may be harder to predict what the final value of your business may be in the future
- No guarantee as to whether you can sell the business
- The business could fail
- You may have to postpone a sale if at the time you wish to retire the conditions for a sale are poor
Making independent provision – Advantages
- If you use a pension you or your business get tax relief on the contributions
- The money can be invested in a way that matches your attitude to risk
- Money grows tax efficiently in a pension or ISA
- At retirement you can transfer your pension into flexible options such as income drawdown or phased retirement
- It is independent from your business
- It can provide income for others such as spouse or dependants when you die
- Normally there is no tax to pay if you die before taking your benefits
- It is not possible to access the fund until age 55, removing the temptation to dip in before you retire
- The value of investments can fall as well as rise
- The value of benefits is not guaranteed
- Your money is locked away until age 55
- There are restrictions on how benefits can be taken
- There are restrictions on how much can be paid in
It’s clear that there are no easy answers.
Think strategically though. Many people find it easier to work backwards, spend time thinking about what income you need to be financially independent and to have the lifestyle that you want. Then work out what lump sum you need to produce this income by assuming an investment return.
Do these things and you will find out what capital sum you need to build, it’s then just a case of building it, simple really!
In all seriousness, once you have done this the hard work really starts and decisions need to be made about how you build your capital base.
By all means use your business as part of your wealth creation strategy; however it is almost certainly wise to have an independent source of capital. You simply need to decide what the independent source is and how you fund it.
This is where pensions can really come into play, you or your business will receive tax relief (subject to certain rules) on contributions, you can decide how it is invested, and it can even be used to help your business. Obviously it is not all good news, there are restrictions for example with regard to how and when you can take benefits but they can certainly play a part in helping you to create wealth independent of your business.
Now, back to the original question, aren’t pensions a waste of time and cost too much money?
Well, it’s true that over the years many investors have been disappointed by how their pension has performed. However, there are a great many things that can be done to improve, although never guarantee, performance.
Whether it’s an existing arrangement or you are considering a new plan, take another look at pensions, you may be surprised at how they have changed and how they can compliment your business to help you achieve your ultimate goal.