Retirement, or rather the attitude of people who reach retirement age has changed. It seems that an entrepreneurial mindset is not only for young whippersnappers. From cakes and dressmaking to classic car restoration, many who might traditionally opt for an easier, slower pace are becoming later-life entrepreneurs.
Thanks to recent reforms to pension rules, retirees can now access their entire pension pot at 55. For entrepreneurial older workers, that can signal the start of an exciting new adventure. One in 10 over-55s who are due to retire in the next 18 months may be considering drawing down on their pension pots to start a small business or go into consultancy, according to a recent survey.
When asked why, more than a third said it was because they had a lifelong dream to be a business owner, while a quarter wanted to turn a favourite hobby into something more lucrative. Nearly one in five were driven by the urge to use the experience and skills gained throughout their professional career to supplement their pension income.
This is not surprising. Britain is being hailed as the “self-employment capital” of Europe, and people who set up businesses later in life have a much greater chance of success as they have the benefit of experience and financial wherewithal.
To fund your new business in the most tax-efficient way, you need to plan how to take the cash out of your pension pot. First to be able to withdraw cash from your pension you will need to turn your pot into a flexible drawdown account. Your pension provider can arrange this for you directly, or you could ask a financial adviser to help you set it up. Then you have a number of options. One is to take 25% as a tax-free lump sum from your pension pot when you reach retirement age. This could be the large cash injection you need to get things off the ground.
Another option is to take smaller amounts as and when you need them. These withdrawals could still be taken from your tax-free lump sum allowance, up to 25% of the overall fund.
Once you have withdrawn all your 25% tax-free lump sum, the rest of your pension is classified as income and any further withdrawals will be counted as earnings. That means you will have to pay income tax on anything else you withdraw from your pension that tax year, if your total earnings exceed your personal allowance (£10,600 in the 2015/2016 tax year).
In other words, you need to consider the tax liabilities caused by withdrawing anything over and above your tax-free lump sum. Withdrawing significantly more than 25% of your pension in a single tax year could push you into a higher income tax band, especially if your business is paying you a wage, or if you have other sources of income in the same tax year. As a result, it may be worth planning to spread out your withdrawals over several tax years.
To start or not to start
It might be tempting to plough a large proportion of your pension into your new venture at the start. If the business is successful, it should provide extra income and become an asset that grows in value. But remember that you’re taking a risk with money you originally intended to provide you with a secure income, which you will find difficult to replace if things don’t go smoothly.
What’s more, wealth held in a pension fund is tax-efficient if you leave it where it is. Investments are not liable to capital gains tax while they are in a pension, regardless of how much they grow. Furthermore, when you die the money held in your pension will not count as part of your estate for inheritance tax purposes and can be passed on tax-free if you die before the age of 75.
Are you ready to take the plunge?
If you have built up a large enough pension pot to make taking a risk worthwhile, you could find yourself with an exciting new business to look forward to in retirement. But it is important to understand the risks.
To find out more about ways to use your pension – and if you take the plunge, the help you need with your business finances, please call us.