Pension Freedom: A Source of Business Finance?
Adam Tavener looks at four ways in which business owners can use the new ‘pension freedom’ legislation to gain funding for their company
Since the 6th April 2015, anyone over the age of 55 can use accumulated pension fund in any way they wish, including taking their entire pension pot out in a single lump sum.
Small business owners looking for funding to support or grow their companies have been weighing-up the potential benefits that pension freedom might bring. However, the practicalities may prove less attractive.
The new rules do not alter the fact that only 25% of an accumulated, untouched, pension fund is available tax-free. Any further withdrawals are subject to income tax in the year they are taken. For most small and medium-sized enterprise directors that will probably mean hitting the higher rate tax band of 40% or 45%.
As with any type of funding, there are also other influencing factors to consider beyond the pensions themselves: retirement and exit strategies, the business’ overall tax position, or the existing involvement of other funders.
However there are several possible pension-based funding options worth considering for your small business; here are four:
Use the entire pension fund for an instant cash injection into the business
For the sake of simplicity, let’s suggest a business requires £58,500 (half of an average accumulated business owner’s pension pot). Under ‘pension freedom’, allowing for tax, the outcome is:
£29,250 (if the full 25% tax-free allowance is taken in one go from the total £117,000 pot)
£17,550 (the remaining £29,250 minus a 40% 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: £46,800
Business financing through two pension withdrawals
In this case, a business may need a total investment of, for example, £35,000 but an immediate requirement of £12,000 – taking the remainder out at a later stage.
There is still the same drawback as using your entire pension fund in one instalment. The first 25% is tax free, while the rest is subject to income tax whenever it is taken – although timing is important as to whether the sums are taken in the same, or two or more tax years. It is also likely that multiple transaction arrangement charges may be incurred for each withdrawal.
Small amounts of pension-based funding frequently
Where small capital sums or ‘ad hoc’ 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. Again, transaction arrangement charges for each withdrawal must be considered.
A Self Invested Personal Pensions (SIPP) and Small Self Administered Scheme (SSASs)
For owners or directors with accumulated pension funds greater than £50,000, a SSAS or SIPP could provide a pension-led funding opportunity. Professional advice is required, but owners can decide where pension funds are invested. There is no minimum age for the funds being accessed. However, this funding model requires a pension pot with a level of maturity that can support a sizeable transaction.
The funds released from the pension fund to the business are tax-free, but subject to the business repaying the capital taken from the SIPP/SSAS directly back to the pension fund on commercial terms, thus offering potential for pension-fund growth. Furthermore, if the repayments are met then business owners can access the scheme again for further funding at a later date.
While the natural impulse would be to take advantage of ‘pension freedom’ now, business owners and/or directors must take time and consider seeking expert advice to consider the full range of available funding options, including benefits and risks.
However, the right decision could certainly lead to more pension pots working effectively to back UK business.
For more information on both traditional and alternative funding options, take a look at our sister site’s raising finance section here.
This article was written by Adam Tavener, chairman of Clifton Asset Management.