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Wednesday, 17th April 2024
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Business owners should ring-fence their wealth with a pension Back  
For any business person with a long-term business exit plan, leveraging the most wealth possible out of their pension should be the first step in wealth management, writes Brian Sullivan.
More than half of Irish entrepreneurs do not have a pension, according to a new study by Bank of Ireland Life, drawing on findings from both the self-employed and business owner communities.
The extent of pension tax relief available to self-employed people and business owners is significant and in many cases it is more tax efficient for business owners to put a portion of their company profits into a pension instead of a pay rise.

Many business-owners have difficulty distinguishing between their personal wealth and their company wealth and yet for their own benefit and that of their dependants, business owners need to consider how best to transfer their corporate wealth before tax into a pension plan.

This ‘ring fencing’ of profits, for both business owners and the self-employed, can be of great comfort particularly when approaching retirement age. What is interesting is that, of those self-employed entrepreneurs who don’t have a pension, 33 per cent paid into an SSIA proving that the capacity to save for the future is there. A pension can offer almost double the SSIA bonus through tax relief for a self-employed person, while the tax relief incentives for business owners are even greater again. A pension also benefits from tax-free growth, making it the most tax-efficient savings vehicle on the market.

The breakdown
From September to November every year, Bank of Ireland experiences a large volume of customer queries regarding pensions. An example of the varying types of business people and their queries are detailed below.

David Whelan, a 30 year old with annual earnings of €100,000 intends to retire at the age of 65. A start-up business entrepreneur, David Whelan, runs his own graphics company, which supplies innovative image solutions to clients in Ireland and the UK. Following careful consideration and advice from his accountant, Whelan has recently registered as a limited company. While this means that the recent October 31st self-assessment tax deadline will no longer be key date for him, he will have to file accounts on an annual basis. From a pension planning perspective, Whelan’s situation has changed dramatically in that he can now pay significantly more money into his pension using current maximum funding rules.

Anne Doyle, aged 34 is a self-employed communications consultant with one part-time employee. She has been in business for herself for two years and her yearly earnings are €82,000. In terms of her retirement savings, she has €12,000 in a paid-up occupational pension scheme. As is the case with many self-employed people, Doyle is now the sole person responsible for ensuring she has an adequate fund at retirement. Because she is self-employed, Doyle will have an annual tax bill to pay, based on her earnings by the October 31st tax deadline every year. It makes good business sense for anyone in this situation to reduce this tax bill in so far as they can, while also preparing for a comfortable retirement.

Doyle’s paid-up retirement fund will continue to grow in the period up to her retirement, however it will not be sufficient to maintain her current standard of living in retirement. While she is self-employed and only in her second year of business, she is drawing a good income and her overheads are low. At this stage she should try and pay the maximum pension contribution allowable for tax relief for someone of her age, which is 20 per cent of her net relevant earnings. Her annual tax bill could be almost cut in half by making payments to her pension as she is a higher income tax earner and is entitled to tax relief of 41 per cent.

Women generally have what could be described as fragmented careers as some women take time off work or go part-time as they rear their families. Therefore it is important that someone like Anne Doyle makes the maximum pension payment she can now, in case her personal circumstances change in the future. This principle is applicable to any business person. She should also review her pension fund annually with her accountant to ensure that she is on track for a comfortable retirement, especially if she plans to retire earlier than age 65, as many women do.

Louise and John Murphy are in their thirties and run a business, Limited Company, a graphic design house. They each draw a salary of €45,000 each after three years in business. However, they have no retirement savings in place. This is typical of many business people who are faced with other challenges during their first years in business. Our recent study found that the biggest reason for not having a pension provision in place is that they never got around to it. As is also the case for many people, it was only after a casual conversation with a family friend who works in an accountancy firm that they realised the power of a pension from the point of view of extracting profits from the business in a tax-efficient way, while securing their financial future. Very often business owners see their business as their pension, and therefore don’t prioritise the need to secure their financial future independent of their business.

In order to finance the business, this couple invested all their savings and took out a small business loan from the bank to finance their business, and now with a decent portfolio of clients they are starting to turnover a decent profit. At this stage, they should prioritise setting up an executive pension arrangement in order to effectively provide for their future. For example, very often it would be more tax efficient for them to put a lump sum into their pension than to give themselves a salary increase. Most Irish entrepreneurs work significantly longer hours than the average person, many hope to retire early and so must ensure they have a decent pension in place.

Finally, Patrick Lyons, aged 38 years runs his own restaurant and has been in business for himself for the past five years. He is now earning €70,000 a year and has retirement savings of €100,000 built up and is cognisant of the importance of pension planning. His business is going particularly strong at present. The restaurant business however is unpredictable, and as he is both the owner/manager and chef, Lyons knows that either a rival restaurant setting up nearby or an unexpected illness could put him in a difficult financial situation. He also has family members employed in the business. He is making regular contributions to his pension but he could potentially make single once-off lump sum payments when the business is going well.

It is better to pay in as much as possible to your pension in the earlier years as this gives the fund a longer period of time to produce good returns. Lyons is approaching 40, at which point he will be able to contribute up to 25 per cent of his net relevant earnings (increased from 20 per cent of earnings) to his pension and get tax relief of almost 50 per cent. While the business is going well at the moment, Lyons will inevitably need to re-invest some of his profits into its upkeep. Now is the time for Lyons to prioritise his pension savings so as to ensure he can maintain his standard of life into well into retirement.

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