Many business owners see their business as their retirement fund. But if things don’t work out according to plan, having a private pension fund to fall back on could be essential to a comfortable retirement.
Why save into a pension?
Reducing tax on profits
The self employed (sole traders and partnerships) are not able to shelter their profits from tax in the same way as a company owner can. By putting money into a pension they can save tax at 45% or 40%.
Company owners can save corporation tax at 19% by funding their pensions from company profits because pension contributions are treated by the taxman as allowable business expenses.
Leaving a legacy
Under the current pension rules, you can leave your pension fund as an inheritance (with no inheritance tax payable on it) to your loved ones.
If you die before 75, the pension fund can be drawn tax free in its entirety by your chosen beneficiary so long as it is within the so called ‘lifetime allowance limit’ (currently £1.073M).
If you die after 75, whoever you leave your pension fund to will have to pay income tax at their marginal income tax rate (0%, 20%, 40% or 45%) when they withdraw money from it.
The current pension tax relief regime may not last forever
One of the benefits of the government being preoccupied with Brexit in recent years is that pensions advisers have enjoyed an uncharacteristically calm period with no rule changes of note. A key risk for the future is that the tax relief granted on contributions made by higher earners may be reduced, even more so in the light of the need for the government to find a way to pay for the COVID-19 impact.
We therefore encourage clients to make the most of the status quo if they are 40%, 45% or 60% taxpayers (in the current 20/21 tax year 60% tax is paid on earnings between £100,000 and £125,000) as currently full tax relief is given on pension contributions.
New, higher, annual allowance
At the March 2020 Budget, the Chancellor increased the amount that higher earners could save into their pensions. Previously, anyone with taxable income in excess of £210,000 was limited to an annual pension contribution of £10,000, which was a reduction of £30,000 on the £40,000 that lower earners could contribute. Now, anyone who earns up to £240,000 may be able to contribute up to £40,000 to their pension, with the available contribution allowance reducing thereafter. It should however be noted that there is a complication for those who earn over £200,000 and who receive employer pension contributions, so anyone falling into this category should seek advice before making pension contributions.