Is your business your pension? Really?
This blog explains why a one-trick pony may not be ideal and why you need a retirement plan. It makes good business sense to have options. The importance of a fall-back option can’t be overestimated.
It might take your business a decade or two to develop into something really valuable. But the attrition rate is huge. According to telegraph.co.uk, 60% of new businesses will fail in the first three years. London, in particular, has a spectacularly low survival rate for start-ups, as the Financial Times has pointed out.
This blog is important wherever you are in the business-creation cycle.
Multi-tasking for beginners
Multi-tasking is one of the essential skills for any business owner. When you launch your own business venture, whether going it alone as a small trader or setting up your own company, the only person you can rely on to get things done is yourself.
That means big workloads, steep learning curves and juggling what feels like a dozen priorities at any one time. Generally having a lot on your plate. That means that important factors can be overlooked, even for the most hard-working multi-tasker. More often than not, these are things that don’t seem to be the most immediate or urgent.
Like planning your finances for retirement.
It is easy to see why, with so much to manage in the here-and-now. Questions about what you will do money-wise when you stop working can fall down your list of priorities. According to studies, as many as a third of self-employed people and small-business owners don’t have a retirement plan.
The crux of the matter is, as with most other aspects of your professional life, entrepreneurs are self-reliant when it comes to financing their retirement. You have no company pension plan, no automatic or compulsory contributions to fall back on. If you want to put money away for later life, you have to be proactive about doing it yourself.
Thinking about retirement can be one more task to add to an endless to-do list. But this needn’t be such a terrifying prospect. Here are some key actions to consider now, to start taking the right steps forward.
Start small, end big
If you are a young business owner, you can follow the ‘save half your age in pension contributions’ rule. At age 26 save 13% of your income and keep this link in place throughout your career. By age 36 it is 18% and so on.
The main problem with this model is that it penalises late starters – those in their 40s, for instance. Time and compounding aren’t on your side.
Those who have recently set up a business are keen to reinvest profits back into growing their company. Others are not making much in the way of profits at all yet. As for real saving, this can seem like an impossible fantasy. People mistakenly believe that if they cannot meet the full contribution limit on a pension plan, ISA or similar, it isn’t worth starting.
In fact, the exact opposite is true - it is best to save as soon and as early as you can, however small. The more your business grows, the more revenue it generates, the more you will be able to put aside for your retirement. But leaving it too long can leave you with a lot of ground to make up in later life. If you haven’t already, start right now and get into the habit of saving.
Get tax benefits from your company
In terms of pension savings, working as a limited company can bring real dividends. By making direct pension savings through the company, you avoid the NIC payments you would have to pay if you drew a salary first and then invested into a pension fund.
You can gain additional tax benefits from including other members of your family in the business, such as your spouse. By having a partner involved as a co-director of your company, you can make direct pension savings in their name, too, enhancing the tax benefit. The same principle applies to all assets and savings you can accrue in more than one name, e.g. both of you taking out ISAs using earnings drawn from the business.
Using your business as a pension fund
One common approach many business owners take to retirement planning is viewing the company as their nest egg. When the time comes, the plan is to sell up and live on the after-tax sale proceeds. This may be fine – if you have excellent foresight, a wagon-full of good luck and perhaps a spare crystal ball or two.
Selling your business, and especially selling for a substantial sum, is far from straightforward. It can take years of hard work to build an operation that is profitable, stable, successful and set up in a way that is as attractive as possible to would-be buyers.
You need to think very carefully about how you use the proceeds from a sale. If you aim to try to live directly off the receipts, you are taking a gamble that the amount you get will be sufficient. Better, and safer, to invest the money that you get.
Many business owners make a common mistake. They have a goal to sell their business for £X millions at a future date or by a certain age. The better way to do this is to understand how much income you need to live on and work backwards to see how large the company sale value needs to be.
These options are best discussed with a financial planner.
Diversifying your investments
Finally, business owners want to prioritise reinvesting profits back into their business in the hope that they will achieve a snowball effect. Of course, the more successful your business is, the more revenue it generates as a result of your hard work.
The more you invest in your business, the more wealth you can build up and the more money – in theory - you can set aside for your retirement.
But any sensible investment strategy involves a diverse portfolio. From the point of view of your personal finances, this should also apply to how you approach profits from your business. By putting everything back into your company, you are heaping all your eggs into the one proverbial basket, banking everything on continued success.
To cover potential risks and optimise your long-term financial position, it pays to start building a broad portfolio as soon as your business starts returning profits.
Double your chances of success
Your own business consumes your time, energy and thought. You need to be ever-present and on-call. At night, you probably even dream about its profits or losses. Let’s face it – it can dominate your life.
Co-investing in your own retirement pension is totally different. Set up a monthly direct debit, sit back and relax. A good chartered financial planner will create your plan, agree the contribution level required, build an appropriate investment portfolio, and the markets will do the rest.
Allow time to work for you – with more than a little help from our old friend, compounding. No involvement, no oversight, no worries. And, when the time does come to sell your business, you and your family will have two income sources to finance the life you want.
To talk to one of our financial planners about your retirement plans, please get in touch with Capital today.