Ensuring access to sufficient funds to support a desired lifestyle is a central tenet of retirement planning. Since retirement also implies stepping back from work commitments, the logical process for most entrepreneurs and business owners seems to be to divest themselves of their business obligations by selling-up. This would simultaneously raise capital which could be used to purchase an annuity, repay debt, or to fund other investments, and relieve the owner of all responsibility for the business. The options open to owners who want to sell have been widely reported – but what are the choices for business leaders who want to continue to draw an income from their business?
Psychology at play
The reasons behind business owners resisting retirement are frequently more complex than simply financial. To run a business successfully demands grit, determination and to some extent a certain bloody-mindedness! Running a business is no easy ride: the hours are long, there’s no job description, nor delineation, and a high level of self-assuredness is needed when battling adversity. So for the few who do succeed, it’s little wonder that letting go can often seem so hard. It can seem like putting your own child up for adoption when it’s already reached adulthood and all its positive traits are the result of your careful parenting! So handing the business over to complete strangers who do not understand the company’s ethos and ways of working can be extremely difficult to contemplate. If there is a period of handover, this can sometimes lead to conflict as the new owners try to make radical changes with which the existing owner disagrees. This can have an adverse impact on the employees, customers, suppliers and other stakeholders in the business.
Retirement can come as a shock, too. While courses are offered to help retired individuals structure their day and fill their time, the prospect of retirement can be less appealing than most people think. Twenty-four hours can be a very long time when there is no requirement for targets and goals to be set.
Drawing an income from the business may mean more than simple financial gain and can also be a way of retaining a sense of importance and involvement.
Business owners looking to retain a level of control and input have three broad routes open to them:
i) Hold on tight and carry on actively working in the business.
ii) A partial or phased sale but retaining an active interest which will generate direct income.
iii) Selling the business without retaining an active interest but continuing to draw some income.
i) Hold on tight
There are some fundamentals that the owner-manager needs to review with his advisors if he continues his involvement with the business, possibly with an eye on an outright sale at a more optimum time. The key areas to consider are listed below and are designed to ensure that tax liabilities are minimised and income maximised.
- Remuneration strategies: make sure income generated by the business is optimally distributed among the family as employees (if possible) thus utilising everyone’s tax allowances and lower rate bands to reduce tax liabilities. To achieve this, all the family members will in fact need to work for the business and ‘earn’ their salaries.
- Use of premises: check any lease conditions. If the business is responsible for repairs and enhancements, you will probably be entitled to tax relief on the costs. If you are the ultimate owner this can also enhance the value of your property holding as well.
- Dividend distribution: Drawing cash from a family company by way of dividend rather than salary means National Insurance Contributions (NIC) would not be due, and transferring shares to family members with little or no income can reduce the overall tax liability (but does deprive the owner of income).
- Capital Tax planning: business asset taper relief can reduce the effective rate of capital gains to 10%. There should also be specialist planning in place to reduce the potential Inheritance tax liability facing an owner-manager looking to eventually sell the business.
- Transfer of shares: Any shares presently held by grandparents can be transferred into a child trust fund to pay for their grandchildren’s school fees and reduce or avoid income tax.
- New pensions provisions: make sure you are getting optimum benefit from the new pensions provisions introduced after A-Day. For example, companies could usefully look to a group SIPP in which their pension funds would be clubbed together to purchase premises which would then be leased back to the company, with the rental income enhancing their funds free of tax.
- Employee benefit schemes: consider setting up an Employee Benefit Scheme (EBS) under which corporation tax relief will be available in respect of contributions by the company - but only when cash is paid out to the Directors or employees. Loans can also be made to working shareholders via an EBS, which avoids having to make a payment to HMRC whilst there is a loan outstanding to a shareholder or a member of his family. An EBS can also provide an inheritance tax shelter and alternative long term savings plan.
ii) Partial sale/phased sale
Owners who are not quite ready to exit a business completely could consider a partial sale or a phased sale of the business. This can involve selling a stake on to an outside party or to some key employees of the business and there may be arrangements for the remaining stake to be sold some time in the future – perhaps with an agreed formula for calculating the price. The company is effectively acquired but the owner continues to deal with customers, suppliers or employees of the company. The former owner would probably continue to take a salary from the company but would also have received a capital sum, taxed at a maximum of 10% (subject to a few straightforward conditions). Burdensome administrative tasks could be passed to the new owner while the seller continues to see their favourite clients and helps develop a good relationship with the new owners.
Any salary would still be liable to tax and NICs but any dividend paid on retained shares would not attract an NIC charge. It’s crucial, of course, to have a water-tight agreement with the acquiring company which lays out what percentage of earnings you will receive, the exact involvement in the company and any arising client issues and of course, the duration of the agreement. It should be possible to phase out the activities over an agreed time span in which time the original owner has continued to earn an income, introduced clients to the new owners to protect the goodwill of the business and helped to maintain the standards of service. Specialist advisers can help to find and review potential partners and draw up agreements and contracts to regulate the relationship.
iii) Selling the business but retaining some income
The retirement of an owner-manager is a critical moment. If the aim is to continue to take an income from a business, whether an owner-manager is actively involved or not, the business’s longer-term success will need to be certain. If this is the chosen path, the following need to be considered:
- Pension scheme rules: be aware that the annual limit of £215,000 (rising to £255,000 by 2010/11) does not apply in the final year to retirement, although investors must still take care not to exceed the lifetime limit of £1.5 million (rising to £1.8 million by 2010/11). The local tax inspector will need to review the situation and give clearance if a higher payment is made in the year leading up to retirement. Post A-Day, directors can now retire from a pension fund/SIPP at the age of 50 (to be raised to 55 in 2010) but continue to work in the business – leaving owners free to work part-time, e.g. while mentoring a successor, while still drawing a pension.
- Business premises: If premises are owned, consider retaining them and leasing the property back to the new owner. The cost of repairs and maintenance is tax deductible and the rent provides a source of income. If the premises are well located, there is also the potential for capital growth.
- Tax breaks: This is a vital area. Income from a business could attract up to 40% tax liability but proceeds from a sale should attract only a 10% tax charge. Ultimately the best way to take an income from the business might actually be to sell it, saving on tax liabilities, and invest the money elsewhere! The issue then becomes seeking the right financial advice to make sure the lump sum is invested to support short and long-term financial priorities and to reduce the ultimate inheritance tax charge.
- Retain shares: Being a minority shareholder in the business would provide income via dividends but also means that direction and control of the company is no longer part of the role. Care would be required in this circumstance as a minority holder of shares would have very little influence over dividend policy and other decisions to be voted on by the majority holders.
Conclusion
Letting go of a business you’ve spent a life time building up is no easy decision. Retirement may seem attractive, but handing over the business reins to new leaders who will ‘do things differently’ can make retirement less appealing. There are always options available for any course of action. The key of course is to plan in advance, setting out your long-term financial priorities and seeking sound professional advice.