Pension Funding for Business Owners
Many small business owners spend years making their business a success but neglect their pension funding along the way. It may be that cash was simply reinvested to grow the business or there were other demands on their capital which took priority.
In the past such individuals were able to “catch up” quite easily by making substantial pension contributions in the years leading up to retirement. But this type of planning has been hindered in recent years by the introduction of much lower Annual Allowances (the maximum contributions which may be made in any one year and still benefit from tax relief). The standard Annual Allowance is now £40,000. Unused Allowances may be carried forward for up to three years so long as the individual was a member of a UK registered pension scheme during those years.
What this means in practice is that contributions to Personal Pensions, SIPPs or other Money Purchase Schemes are limited to an absolute maximum of £180,000 in the 2015/16 tax year (assuming no other contributions have been made in the previous three tax years). Future contributions are then limited to £40,000 per annum as outlined above.
The situation is worse if any income benefits have already been taken from a Money Purchase pension scheme. In this case the Annual Allowance is reduced to just £10,000. High earners also face a tapering Annual Allowance if their “adjusted” income exceeds £150,000.
There is, however, a way to boost pension savings. The solution lies in the way that contributions to Defined Benefit schemes are calculated. The Annual Allowance for these schemes is calculated as a multiple of 16 times the increase in annual benefit (after adjusting for CPI). By assuming modest future growth, retirement at the earliest age possible, index-linked benefits and full spouse’s pension, the actual contribution required to generate a future benefit of £2,500 per annum (1/16th of £40,000) may be substantially more than the deemed contribution of £40,000.
By establishing a Small Self-Administered Scheme (SSAS) using Defined Benefit rules it is possible to take advantage of this funding “anomaly”. For example, a 44 year old, married Company Director would be able to make an actual employer contribution of c. £430,000 to such a scheme in the current tax year assuming no other contributions in this or the previous three years.
It should be noted that there is no ultimate requirement for the scheme to pay the benefits in the format used for the original calculation. It is also perfectly possible to transfer out of the defined benefit scheme to a money purchase scheme at a later date. Appropriate financial advice should always be taken.
Pension contributions remain the most efficient method of extracting profit from a business. No Corporation Tax, no National Insurance and 25% of all benefits tax-free. There is no telling how long this will remain the case as the Government continues to tinker around the edges.
For further information and individual advice please contact us.