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FOR SMALL FIRMS
AROUND half the hauliers at the Road Haulage Association's conference in Malta last winter had no idea that, should they go bust, their creditors would have no claim on their pension funds.
But if there is a lack of knowledge on this very basic aspect of pensions, it seems likely that other, more detailed benefits that can be gained are even less appreciated.
A report published last month by Bain Dawes and Partners, the Road Haulage Association's partner in RHA Insurance Services, comments: "People running their own businesses often have unrealistic expectations of the ways in which they will be able to secure their retirement financially. Few take retirement planning seriously and equally few accept the proposition that their standard of living in retirement will be jeopardised if they fail to do so.
The main advantage of a pension scheme is savings in tax. A 65-year-old man will at present have to pay around £85,000 for a pension of £12,500 a year. Outside a pension scheme, this sum can only be accumulated from taxed income.
Small self-administered schemes are becoming increasingly popular for owners and directors of small limited companies. Instead of paying money to an insurance company, the owner of the business can retain considerable control over his pension contributions if he so wishes.
Investment of the funds is the most attractive area to many choosing this option. Up to 50 per cent of the fund's assets may now be loaned back to the company, or a subsidiary, provided the loan is on proper commercial terms.
Property can be bought by the fund and leased back to the business, which can help by releasing cash tied up in the company's balance sheet, at the same time providing a sound investment for the pension fund. But there is a liquidity requirement on the fund's trustees — the fund is required to buy an annuity from a life assurance office within five years of each member's retirement.
The fund can be used effectively to pass shares on to the next generation in a family-owned business without incurring any capital transer tax, by acquiring shares in the company. The Inland Revenue checks that the shares have been sold at a realistic price and that the purchase is a sensible acquisition.
Risks are attached to all of these options and can even put a pension in jeopardy. But risks can be reduced with a traditional "safety first" investment policy. Bain Dawes comments: "When a pension scheme has only one member, who is also a trustee and is in control of the company, conventional arguments often disappear out of the window.
" 'Security of capital' and 'long-term steady growth' may well not appeal to the entrepreneur. The argument which suggests that such an individual ought to be rather more prudent in his pension planning is undeniably sound, but fails to convince when the prospect of high short-term returns is offered."
An essential feature of a small self-administered pension scheme is that it must be established under irrevocable trust, with provisions approved by the Inland Revenue.
Contributions are allowable against income tax or corporation tax, and assets in the scheme accumulate free of tax on investment income and capital gains.
There must be an external trustee, approved by the Inland Revenue.
Membership of a scheme is by invitation of the employer, but can extend to all employees, including directors. Because the scheme can be established only by an employer for his employees, partners and sole traders are not eligible.
The cost of administering a scheme need not be high. Books and accounts need to be maintained and audited annually, which can be done normally as part of the annual company audit. The only other records needed are those of the Scheme E earnings of members, which have to be kept for other purposes in any case.
A commitment to contribute for at least five years, or until members leave or retire, is required by the Inland Revenue, which imposes a degree of financial discipline. There is no minimum contribution, but in practice the expense of running one's own scheme becomes disproportionately high if contributions are much less than £10,000 a year.
The cost of the scheme may be as much as £2,000 in the first year and £500 thereafter, with additional costs depending on the number of members.
Pension and tax planning is complicated, and needs time and expertise. The situation of each company and its owner is different, not only in terms of its financial position but also in what the owner wants to achieve. In Bain Dawes' view, the tax advantages and flexibility of small self-administered pension schemes make them the best arrangement for directors and their families.
by Jack Semple