Nathan Long, senior pensions analyst, provides an overview of the options for saving while working (and why pensions remain a hugely valuable option).
Given the commitment, dedication and single-mindedness needed to run a business, it would be easy to forgive business owners for neglecting their personal finances.
Regardless of the riches awaiting those who sell a highly successful business in the years to come, it remains crucial to squirrel away sufficient monies for life after work.
Generally, most people require somewhere between half and two-thirds of their income from work when they decide to retire, which means saving significant sums over the course of a working life.
How do recent pensions changes affect my options?
The tax efficiency of employer contributions has historically promoted pensions to be the principal home for the retirement savings of business owners. However, a raft of recent changes has made revisiting personal finances imperative.
April 2016 brought a change to the taxation of dividends, as well as a drop in the amount that can be paid into pensions, both over a lifetime and annually.
These changes follow hot on the heels of a pension overhaul, where members were handed full flexibility to draw as much or as little from their retirement savings as they want, when they want, providing they are over the minimum pension age (currently 55).
These are hugely popular amendments, not least because they allow people to easily pass their pension on to their family on death. This inheritability is sure to be a huge attraction to business owners. Large sums have been shovelled into pensions since these changes were introduced.
But what of these other changes? A tweak to dividend taxation means that the first £5,000 of dividend income is now tax free, with the remainder taxed at 7.5%, 32.5% or 38.1%, depending on whether the recipient is a basic, higher or additional rate payer. Assessing how best to personally extract profits from a company through a combination of dividend, salary and pension remains a task for the accountant, as you might expect.
Regardless of the exact split between salary and dividend, employer pension contributions look set to retain their advantage. They remain free from income tax and (crucially) free from national insurance, just like dividends, as well as being free from corporation tax, like salary.
In fact, pensions are so attractive that the government has sought to limit the amount the highest earners can save. The lifetime allowance (a cap on your total lifetime pension value) has been slashed by £250,000 to £1 million. Transitional protection might be available, so anyone who thinks they may be affected should speak to a financial adviser.
In addition, the maximum annual pension contribution for those with income over £150,000 has fallen. The £40,000 standard annual limit is whittled down by £1 for every £2 of income above £150,000. This limit can drop to as low as £10,000 for those with income over £210,000. This new rule includes employer pension contributions as well as income from dividends, interest and rental property, so it is worth being extra careful.
To bring this to life, someone with income of £200,000 per annum would actually have a reduced annual allowance of £15,000. If this person targets a £100,000 income in retirement – half of that earned while working – they would require a capital sum of around £2.5 million, assuming they draw at a rate of 4%. This rate is deemed broadly sustainable to avoid running out of money in retirement.
ISAs: cash and stocks and shares
Clearly, high earners who are constrained by these limits cannot use a pension for all their retirement savings, and should look to ISAs to shelter further monies from the tax man.
Principally, ISAs take two forms: cash and stocks and shares. Holding cash is a good home for any monies needed for a rainy day, whereas investing in the stock market is generally more suitable for long-term retirement savings. Stocks and shares ISAs provide a tax shelter for investments and act as valuable supplement to pension savings. ISAs have an annual contribution limit of £15,240 for the current tax year, which can be split, as required, between the different types.
It’s not all doom and gloom for higher earners. The chancellor is also increasing the amount that can be paid into ISAs each year to £20,000 for next year, and is finalising the rules for a new lifetime ISA (LISA).The LISA looks poised to provide a 25% government uplift in subscriptions for the under 40s, provided they access the monies after the age of 55 – the equivalent of a £1,000 bonus on a £4,000 subscription.
There remains a squeeze on higher earners with seemingly little political incentive for this to change, despite the chancellor’s ISA tinkering. Whether business owners are focused on saving for retirement, or extracting company profits tax efficiently, pensions remain a hugely valuable option. Self-invested pension plans (SIPPs) provide a wide range of investment options and, when teamed with the new flexible pension options at retirement, allow people to have control over their own future.
About the author
Nathan Long is a senior pensions analyst at Hargreaves Lansdown, a leading provider of investment management and pension products and services to private investors and employers in the UK.