149- My Business Is My Pension, Avoid This Red Flag

Small company business owners often believe that their business is their pension and that pensions are inefficient and subject to too much change to even start with in the first place. 

Benjamin climbs on his soapbox in this episode to encourage you to re-evaluate this false economy. 

And: 

Your personalised business owner blueprint 

Here's a link to the tool Benjamin mentioned in the episode. Takes 5 mins, receive custom results straight away and it's completely free. 

Join Benjamin Mitchell (themoneyscot), serial hater of financial jargon, as he helps make your finances clearer and ensures you never make another financial mistake.

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Disclaimer - please note that nothing in this podcast can be relied upon as financial advice and the content is provided purely for information and guidance purposes. Please seek independent, regulated financial advice relevant to your situation.

Transcript

0:09

Hello money nerds and welcome to episode 149 of Heads Up on Money. Can't quite believe I'm saying that. That is absolutely mental. I feel like I just recorded the 100th episode special and we're almost at 150. Thank you again from the bottom of my heart. Really appreciate the Money Nerds for listening in every Friday. I know some episodes will be of more relevance to you than others, but I do appreciate you remaining with me on the journey, and I hope you have learned a lot from the podcast over the last three years. Mental. Mental that I'm saying that. Anyway, getting down to this episode 149, I'm talking about one of the biggest red flags I see, particularly when I speak with limited company business owners, directors of their own limited company. When I approach the subject and I say, So have you thought about pension funding? Have you got a pension? I've heard a lot of time the director come back to me and they will say, My business is actually my pension. My business is my retirement plan. And I love the tenacity, I love the drive, I love the ambition, but it's dangerous. Not only is it dangerous because you are having all your eggs in one basket in the similar way that you wouldn't invest or shouldn't invest in one single share, you're putting all your eggs in one basket, but you're also missing out on the potential for tax efficiency, both on an ongoing basis leading up to retirement and in retirement. So welcome back to Heads Up on Money. By the end of this episode, if you're a company director, I'm hoping I will have educated you more on why saying your business is your pension is not a good thing. So we're talking today about why that is the case. Now on the surface it sounds logical because you've built up this beautiful baby of yours, it's something that's valuable, hopefully something that's profitable, and it's something that supports your lifestyle. But here's the truth: relying solely on your business as your retirement plan is honestly one of the biggest financial risks you can take. So I'll explain in this episode why thinking like this is so common amongst company directors. I'll try and outline the pros and the cons of using your business as your long-term retirement plan. I'll go into a bit on the technicalities of pensions, including what's changing next year, which is probably what you've heard about, and probably is putting you more and more off funding a pension in the first place, but that needn't be the case. And ultimately, if I can try and educate you to take from today, if nothing else, then how to create a more secure and balanced financial plan for the future. So let's start with why this belief exists. Why do company directors say, My business is my pension, Benjamin? So if you run a limited company, then your business will probably often feel like your largest financial asset. And of course, it's your income source, it's your legacy. You may have this view that your business is this pot of money that will be used to pass on to the next generation. It's not only for you, but it's for your loved ones, your partner, your children if you have one. And whilst that can be beneficial and can offer tons of peace of mind, the danger is people fall into the trap of saying, I'll just sell my business later and that will fund my retirement. And yes, that can work, but it relies on some very big assumptions, and pursuing it in that vein closes doors from a tax perspective. It will be far less tax efficient to plan for the never never in the future and hope that that comes true than it would be to go into this with your eyes open now, still nurture your business, but also reduce some of your risks by considering pension funding. Now, of course, as always, with heads up on money, this podcast is for financial guidance only. It's not financial advice. Please speak to an independent financial advisor relevant to your own situation, blah blah blah. There we go, that's the compliance terminology and jargon out of the way. Please seek regulated advice, folks. So before I get on my soapbox and tell you why every business owner should strongly consider funding a pension, maybe if we can look at the pros of um the directors who do say their business is their pension. Of course, there are upsides to that. If your pen if sorry, if your business is really profitable, if it's doing really well, there's a strong market for buying your business, then potentially you could be in receipt of a significant payout in the future. And you can control the growth, the strategy, and ultimately the value of your business. You've got a lot of autonomy over it, and people like having that control over their own destiny. Having a business can be tax-efficient in some cases because of something called entrepreneur's relief or business asset disposal relief, badger, as it's now called. Don't ask me why. Um, where that can ultimately reduce the level of capital gains tax you may pay on the sale of your business. And of course, you've got lots of flexibility in regards to the timing. You can choose when to sell your business, when the right time is, when a suitable buyer comes along. Again, lots of autonomy, and people do like that. But it's time for the reality check, and this is where things do get a bit serious, and some of the frank conversations I have had with directors in the past. Selling your business is not guaranteed. That's the obvious one. Your business is not a guaranteed investment because markets change, industries decline. Obviously, we're seeing that very much topical at the moment with the whole AI space, and none of us know what's around the corner, none of us know if jobs that are here today will be jobs that are here tomorrow. So industries decline, competitions appear, health or personal issues can force an early exit, which may mean your business is not going to be as profitable as you would have liked to have been the case, or you may never get the sale that you expect. When I sit down and do cash flow plans with my clients, we always run a scenario with the sale of the business, but we model that very conservatively, assuming you are not going to get the level of cash injection from the sale of your business that you foresee. Because it's the same way why I never rely on inheritances in the financial plans for my clients, is we never know if they're going to come to fruition. Now, also selling your business or having a business as your pension causes an illiquidity problem. What I mean by that is unlike a pension, your business can be very hard to sell quickly. What if you don't have a perfect buyer lined up? Does that mean you then have to take a sale from an imperfect buyer? Are you going to get less than the value that your business deserves? It's really contingent on finding the right buyer and can also be pretty difficult to value because often, beyond the fundamentals within the balance sheet and the earnings potential of your business, there can be goodwill built in. It depends on the expertise of the buyer. Again, I'm trying not to teach you to suck eggs here, folks, but these are things you need to be thinking about if you are saying your business is your pension in the future. Perhaps one of the biggest risks to this statement is that very often, more often than not, for smaller limited companies, which are the backbone of our economy, I absolutely love them. I love working with limited company directors, but you are pretty much the business, the key person within that business. If you stop, the value of the business may drop dramatically, and people do not think about that. Often these are structured as businesses with companies house because they're limited entities in their own right, but in reality it's just you. Let's be honest, you're running your own future. It's maybe not a business in the traditional sense. It is in the eyes of the tax man, but the reality is if you stop, the business can stop. And even if you are not stopped by something inadvertent and unforeseen, if illness doesn't strike or inability to work, then you may have some kind of emotional attachment. I've seen that before, is that many over many owners will overestimate their value of their business because it's their baby. It's taken them years of blood, of sweat, of tears to grow this business. They've made countless sacrifices along the way, cancelled social engagements, they've caused potential rifts with family members because they've put almost everything into their baby, and as a result, they may exaggerate how much their business is going to reap them in the future. So be really, really hesitant to apply over-optimistic assumptions in how much your business is going to be worth. Impractical assumptions is obviously another one. The my business is my pension strategy, obviously assumes your business will still exist at retirement, it will be profitable, someone will want to buy it, the person who does want to buy it will want to pay a good price for it, and they will be in a position to pay a good price for it at the exact time that you hope to become dependent on that capital. Lots of ifs and buts there. But in reality, very few times have I seen something that ticks all of those boxes. Rarely has a director come back to me and said confidently they know the answer to all of those things. So why are pensions the answer? Well, let's contrast that with pensions. So as a reminder, I'm not going to go into the ins and outs of pensions too much in this episode. We've done it countless times in the podcast. But from a business owner's perspective, pensions are pretty good. Pretty good because they offer you masses of tax efficiency. Because when you pay into a pension, typically as an employer pension contribution, you're paying it as the business into your personal pension. It's corporation tax relief deductible, which means everything that goes into your pension comes off your top line, and only the remainder is subject to corporation tax relief. Sorry, subject to corporation tax. The difference is corporation tax relief, if that makes sense. So effectively, you're reducing your company tax bill. Once it's in the pension, the benefits apply to pensions in that there's tax-free growth, income may accrue in the form of interest and dividends, and capital growth may accrue in the form of capital appreciation, and everything rolls up in a lovely, lovely washing machine, and it builds and builds and builds and builds and builds till you've got a lovely pot in the future. And then you can take a quarter of that pot totally tax free. Anything beyond that is taxable, but you can have control over how much tax you realize in every tax year, so you can try and avoid paying higher rates tax on the withdrawals than you need to. But aside from the tax benefits, there's also that separation of risk because your pension is in no way tied to the performance of your business. The underlying investment asset allocation within your pension, if it's a diversified global strategy that is relies on compounding and investments doing their thing and stock markets and all the lovely stuff I talk about every week in this podcast, the fortunes of that are totally immune from the ins and outs of your little limited company. And I don't mean that in a disparaging way, but in reality, your little limited company is going to be small fry in comparison to the wider global marketplace that your pension will be invested in or should be invested in. So your pension is going to be going high and low and doing all the lovely volatility that you should expect when you invest in the markets, all of the normal, natural things that markets do. That's happening on the right, and then on the left, you're running your business, and that'll be subject to its own volatility patterns. But the two of them are totally segregated, there's no link whatsoever. When it comes to a pension, you also have much more predictability in the access. Now I know governments, successive governments, may change the rules of the game. I'm not um ignorant to that fact, but the rules of the game in the future we don't know. But as things stand now, you have an age in which you can access your pension, which is currently 55, rising to 57, and we know that you can take lump sums, you can draw income flexibly. So we've got much more control and certainty over when that pension will fit into your financial plan. Whereas the timelines around your business and the extraction of wealth from your business to your personal balance sheet is not that clear-cut. And with regards to 2027 and pensions and inheritance tax, I've done a previous episode of the podcast on that if you need a deeper dive. A lot of people may say, but yeah, the golden age of pensions, it's over because pensions used to be inheritance tax exempt and with EVERM April next year, 2027, that's no longer going to be the case. So pensions will come into the net on death, but that doesn't mean pensions are no longer good. They're not as good as they once were, but they're still an amazing investment wrapper with which you can grow your wealth and take out wealth in a tax-efficient manner. So pensions are often incredibly efficient for passing wealth down generations. They still are not as efficient as they were, but it just reiterates that planning becomes more important and you need advice tailored to your own situation. But please don't let current news and headlines about inheritance tax and pensions steer you away from it completely and reinforce this misbelief you have that your business should be your pension, that you're better off just taking matters into your own hands, being the custodian of your own future because it's a total false economy. The final thing I will say, of course, is with regards to generational planning, yes, it's not as good as it once was for pensions, but what's the alternative with your business? Let's assume you sell your business, great, but if you don't, and you end up saying the business is going to go to your spouse, your next generation, have you actually asked yourself, can your children run the business? Do they even want to run the business? Would they sell it? Would they then struggle to find an owner? Compare that with pensions, although not as efficient from an inheritance tax angle as they once were, they're much more easy to pass on, much more flexible for the beneficiaries, and often simpler to divide, compared with the intricacies of a business which at times can be highly difficult to value and obviously very difficult to divide and extremely difficult to run unless you're in that space. The other thing I'll say, of course, with a tax planning angle, is often business owners say to me, Look, I will fund a pension, I will get tax relief paying into a pension, but I'm just going to do it in the future once I've sold my business. I'm going to come into a receipt of capital. Let's say you sell your business and you get £500,000, hits your bank account, then you say, Okay, let's get this into a pension. I've heard you talking about pensions every year, Benjamin, let's funnel it into a pension. Well, that's a total false economy because the year in which you plan to put the capital into your pension, you're going to be restricted by your taxable earnings in that year. So it becomes really difficult once the money has moved out of the business into your own name to get it into a pension in one tax year. So you need to be thinking about that as well. Now often the answer, of course, is just a balanced approach. It's not necessarily, as with anything in financial planning, one or the other, business or pension. It's more effective to be business and your pension. The way I like to describe it to clients is think of it like this: your business is the kind of growth and the opportunity, it's the long-term gamble that may pay off in a big way, and your pension is more just the security and stability that underpins it. Your financial plan is not dependent on the sale of your business but will be complemented by the sale of your business. And together they create flexibility, tax efficiency, less risk, and ultimately better retirement outcomes, and that's all we can really ask for. Okay, so have I convinced you, if you're a small business owner, that relying solely on the sale of your business as your retirement plan may not be the most sensible strategy. I'm not saying that a pension is the perfect answer, but often, when used in conjunction with one another, it can lead to the best long-term planning. I really, really do believe that. So I hope I have given you some food for thought. That's all that Heads Up on Money is as I try and leave you with some things to ponder on this personal finance Friday as you head into your weekend. The final thing I will leave you with is that I recently put together what I've called your business owner blueprint document, which will ask you a lot of the things we've covered about today so you can understand where the gaps are in your financial plan. I'm going to leave a link in the show notes for you to complete that if it's of relevance. It doesn't take long to complete. You'll get bespoke one-to-one results emailed to you straight away. It's completely free. I've just put it together because I found that business owners often don't really think about these gaps. But I promise you, if you invest five minutes of your time, which is more than enough that you'll need to complete this, it will give you a lot of value. I hope. So I've been making some tweaks to it recently to account with some recent changes. But anyway, the shoot the link to that is in the show notes. If you want to complete that, I would highly encourage it. And hopefully you get some value from it, and it gives you a bit more peace of mind than perhaps you have at the moment. So I've been Benjamin Mitchell, you've been the money nerds. I'm going to wrap this one up. I hope you found it interesting. If you have, do share it amongst the business owner friends in your life because every small limited company business owner should be aware of this risk that my business is my pension, is a total false economy. I would stand on the streets with placard shouting this if I could, but I can't do that. So I'm going to try and encourage you, the listeners, heads up on money, to take heed of my warning. And I hope it has landed with you. Have a great weekend, folks. Sorry to end on a sombre note. I'll see you next Friday for episode 150. See you next week for the party. I'll see you then. Bye.