In the past a pension was just something to live on in old age, providing you with a solid income in retirement. But thanks to recent reforms you can now access your entire pension pot at 55 – and 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 are considering drawing down on their pension pots to start a small business or go into consultancy, according to a survey by Axa Wealth. 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 put money behind a favourite hobby. 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, with around 4.6 million people working for themselves in 2014, according to data from the Office for National Statistics. That’s 15% of the total workforce, compared with 13% just six years previously – a shift in employment patterns that is particularly relevant for older workers.
Paul Green, a spokesman for Saga, says: “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.
“By your mid-50s you are at the peak of your career and want to advance it as best you can. There is something to be said for being your own boss, and many people thrive when they go it alone.”
Getting started
To make sure you 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 of all, 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. Once you’ve done this, there are a number of options for those starting up. 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.
Watch out for side effects
Once you have withdrawn all of your 25% tax-free lump sum, the rest of your pension is classified as “income” and any further withdrawals will be counted as earnings.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 your 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 carefully consider the tax liabilities caused by withdrawing anything over and above your tax-free lump sum.
For example, withdrawing significantly more than 25% of your pension in a single tax year could push you into a higher income tax band, especially 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.
Another important factor to remember is that when you start taking money from your pension, the maximum contribution allowable will be reduced to £10,000 every year. So it effectively shuts the door on any further significant contributions using the tax shelter of a pension.
Deciding whether to take the plunge
If you decide to go ahead, 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 later in life.
What’s more, wealth held in a pension fund is remarkably 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.
Adrian Lowcock, head of investing at Axa Wealth, says: “The freedom and opportunities created by the pension reforms are fuelling a whole new generation of later-life entrepreneurs.
“But with more choice and freedom inevitably comes more risk, and although small businesses are the backbone of Britain, most fail to make a profit and end up losing all its investors’ money. Anyone considering investing in a small business needs to consider what the loss of their investment and retirement income would have on the quality of their retirement.”
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Self-employment: What you need to know to mind your own business
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