One in 10 consider drawing funds to finance start-ups or consultancies
Most of the hype around the new pension freedoms has focused on personal investment, but we could be about to see a new generation of mature or later life entrepreneurs using their pension pots to start their own business or back an existing enterprise.
In a survey of over-55s by AXA Wealth, one in 10 said they were considering drawing money from their pension to start a small business or go into consultancy. In addition, almost nine per cent were thinking about using some of their pension pot to invest in a franchise business.
One of the problems of withdrawing cash from pensions, of course, is a potentially large tax bill. Under the new rules only 25 per cent of an accumulated, untouched pension fund is available tax-free. After that, any further withdrawals from the pension are taxed as income. Anyone planning such a venture will need to be absolutely clear about the initial start-up and running costs.
A lot will depend on the value of their pension and the type of business they plan to launch. Latest figures from the Office for National Statistics suggest that the median average defined contribution pension of UK individuals aged between 55 and 64 is £25,000.
The sectors most likely to see this surge in small business investment included healthcare, travel, professional services and manufacturing, according to the AXA Wealth survey.
Existing business owners and directors looking to invest pension savings in their business are in a much stronger position. According to Clifton Asset Management, they have an average of £117,000 in accumulated pensions.
There are three main options for all pension savers over the age of 55 looking to fund their own start-up, plus an additional option that only applies to existing business owners.
Take a lump sum
Taking an entire pension out all in one go has major tax implications. Beyond the first 25 per cent tax-free portion, the funds will be liable for income tax, potentially 40 per cent, or as much as 45 per cent where total income exceeds £150,000.
Almost half (47 per cent) of those surveyed by AXA Wealth who were keen to start a business said they intended to use their 25 per cent tax-free lump sum to fund a start-up.
Although this may seem like the easiest way of accessing debt-free start-up capital, prospective business owners should bear in mind that it may not be the most tax-efficient approach in the long-term. That said, it could make sense for some business owners, where allowable business expenses reduce their profit and ultimately their tax liability.
Multiple lump sums
Another option is to divide the sum of money required into multiple smaller parts, for example, releasing £30,000 from the pension by taking £10,000 to launch the business and further amounts later on.
However, the same problems of tax liabilities on amounts beyond the first 25 per cent tax-free portion remain. Timing is also important, depending on whether the sums are taken in the same tax year or spread across two or more years.
Other potential drawbacks include the possibility of incurring multiple sets of transaction charges associated with each lump sum withdrawal and a potential loss in performance of investments.
Smaller, more frequent withdrawals
Where start-up costs are not expected to be huge, later life entrepreneurs could free up their pension savings in smaller amounts, withdrawing a few thousand pounds here and there, perhaps to fund new equipment or purchase stock. They still have to contend with income tax liability over and above the tax-free threshold, but this approach may suit those whose income is close to a higher tax bracket. Some of the leading pension providers have advised that accessing funds in this way, ‘bank account-style’, will need to be thoroughly tested before being made widely available.
This form of finance is aimed specifically at business owners and directors who, in order to make it commercially viable, have accumulated pension funds greater than £50,000 to enable them to back their own business.
“They don’t need to be 55 or over, and should there be more than one owner-director in the same firm, the pension funds can be amalgamated to invest in the business,” says Adam Tavener, chairman of Clifton Asset Management, the company behind pensionledfunding.com.
It has proved popular with business owners, delivering SME funding worth £25m in 2014 alone, according to a report from innovation charity Nesta and the University of Cambridge.
Ultimately the choice of business funding option will depend on individual circumstances and also whether their pension provider can enable them to access their pension savings in the way they would like to.
For those who are confident that their business can produce a decent profit, using their pension to fund a start-up could be a good move. If not, they could end up with an unwelcome bill from the taxman, and putting all of their lifetime savings at risk.