By Adam Tavener, chairman of Clifton Asset Management and Alternative Business Funding (ABF)
Since 2015, I’ve closely watched how Pension Freedoms, one of the biggest changes in pension legislation history, has played out, and in particular, I’ve kept a keen eye on its impact on the small business owner. In fact, in the first year alone, at Clifton Asset Management, we estimated that business owners aged over 55 cashed in around £400 million of pensions to fund new ventures.
More recently, the Office of National Statistics (ONS) has published two interesting pieces of data. First, the number of small business owners over the age of 50 (often referred to as Olderpreneurs) has risen rapidly to almost 2.2 million, to December 2018. Second, the ONS found that business owners over the age of 50 collectively have access to over £250 billion of business funding from their savings. But is tapping into your pension to fund your business a risk worth taking?
Well, study after study has shown that Olderpreneurs run more successful businesses, generate greater profits and create more jobs than their younger counterparts. For instance, a survey by Age UK, the charity for older people, found that more than 70 per cent of businesses started by people in their 50s survive for at least five years compared to only 28 per cent of those started by younger people.
Business owners accept risk daily and learn to control and mitigate against it in order to create the outcome they desire. They are taking responsibility for the outcome of all their transactions and their own long-term financial security.
Risk is also relative. If one accepts that most businesses need funding to aid growth, the money must come from somewhere, and all sources of finance come with some risk. So, if you’re looking at using part of your pension pot to fund your business, here are your four main options.
For those that need a small amount of funding – perhaps a few thousand pounds – the freedoms can be advantageous. However, for those business owners that need significant funding, in many cases this could result in a sizeable tax charge. To illustrate the options, we have based the following on Clifton Asset Management’s average SME director, who has £117,000 in accumulated pensions.
Pension Freedoms:1. Single lump
If a business requires £58,500 (half of an average business owner’s accumulated pension pot), under ‘pension freedom’, allowing for tax, the outcome is:
• £29,250 (if the full 25 per cent tax-free allowance is taken in one go from the total £117k pot)
• £17,250 (the remaining £28,750 minus a 40 per cent higher tax rate deduction. This
will vary depending on the director/owners’ individual marginal rate of tax)
• Making the total available for a director’s loan into the business: £46,500
2. Multiple lumps
This option applies if a business needs a total investment of, say, £30,000, but an immediate requirement of £10,000, with the remainder at a later stage.
There is still the same drawback as the full lump. The first 25 per cent is tax-free, with the rest subject to income tax whenever it is taken, although this can be influenced by the timing of the sums being taken in the same, or two or more tax years. There is also the likelihood of incurring multiple transaction arrangement charges for each withdrawal and a potential loss in performance of investments.
3. Small sums
Where small capital sums or cashflow boosts are needed, pension freedom can allow the release of a few thousand pounds at a time. This still attracts income tax, but is more attractive for business owners with income closer to a higher bracket.
An alternative route - SIPPs and SSASs (pension-led funding)For owners or directors with accumulated pension funds greater than £50,000, a SSAS or SIPP can open the way to pension-led funding (PLF). Under professional advice, owners can decide where pension funds are invested. Subject to fund size, there is no minimum age (so no need to wait until you’re 55) for the funds being accessed. However, the scale of this funding model requires a pension pot with a level of maturity that can support the transaction.
Importantly, the capital released by the pension fund to the business is tax-free, with the business repaying funds taken from the SIPP/SSAS directly to the pension fund on appropriate commercial terms, which offers significant pension fund growth potential.
Whichever route is chosen, it is important that business owners and/or directors consider all of their options and take expert advice as a considered approach could certainly see pension pots being put to work more effectively to back businesses without being subject to a significant income tax charge.
Please note: You should seek professional financial advice before investing your pension in your business