Don’t just build your business – build your wealth as you go

We may all feel that we have our career path mapped out, but life has a tendency to get in the way of even the best-laid plans. That fact makes it vital for business owners to plan how to extract benefits from their companies from the start.

Directors and business owners have unique opportunities to use pensions as a way to extract value from a firm in a highly efficient manner. But it’s also a potential minefield, with risks to be managed, ‘use it or lose it’ opportunities, and changing regulatory obligations.

As a business leader, it’s all too tempting to focus on day-to-day operations. As the equity owner, you have all the risk, and yet you’re the last to get paid. Many business owners neglect their own need to extract value, leave opportunities on the table, and don’t plan a way to de-couple themselves financially from the business over time.

Ahead of Pensions Awareness Week 2023, I asked some experts for their insights into how business owners can improve their own situation through pensions and other mechanisms.

For Olive Ryan, head of client services at Moneycube.ie, what’s needed is a plan to extract wealth over time from the business.

“It’s all too easy to put your personal wealth situation on the long finger while focusing on business growth. A growing business brings demands for investment and can soak up cash,” she said.

“But building your personal wealth, and de-risking your exposure to the business you’re building, needs to be done over time. From dripping money into a pension every month, to exit readiness preparation and investing a lump sum in a year of particularly strong trading, pensions have a major part to play in optimising your financial plan.”

Susan Wylie, partner at accounting firm PKF, advises many business owners in this area, particularly through her involvement in the Small Firms Association. She advocates having a strong grip on the numbers in the business to support good decision making around wealth planning and extraction.

“It’s important for businesses to ask themselves, are they making a profit after taking account of all overheads,” she said.

“Once you clarify your plans about taking money out of your business, you’ll be prompted to look at areas to improve operational efficiency and cashflow, which is good business practice in itself.”

Gerard Tyrrell, pension technical consultant at Zurich Life, pointed out that the changes made to personal retirement savings accounts (PRSAs) at the start of this year will be advantageous to some company directors.

“The legislation does not place any upper limit on an employer contribution to a PRSA as would exist in occupational pension schemes,” he said. “This brings significant opportunities for business owners and other senior employees to fund their pension schemes.”

Here are ten tips for business owners and company directors to get the most out of Ireland’s pension system in 2023.

Have a plan for your personal wealth

Yes, it’s obvious, but have you got a plan, and when did you last dust it down? Most business leaders run an annual planning process, but the same isn’t true on a personal level.

For small businesses, that plan should cover how you hold the equity in your business, from incorporation, to using holding companies, to sharing equity with family members as a way to take out wealth. For larger businesses, exit readiness, succession planning, and widening participation in equity will come into the picture.

Importantly, a plan for your personal wealth should avoid betting the farm on a single event to crystallise your wealth. It’s all too easy to put all you’ve got into growing a business, but the manner of your exit is not entirely in your control. So make building your wealth an ongoing activity, rather than a single destination in the future.

Know what a PRSA can do for you

The start of this year brought significant changes to the rules around PRSAs which company directors and owners can take great advantage of, even if you already have a company-wide occupational pension scheme.

With a PRSA, getting money in is faster and less restrictive, and taking money out is simpler and more tax-efficient. The practical limit for putting money into a PRSA is now €2 million per person, with no benefit-in-kind charges. If, for example, family members are also involved in the business, this offers scope to fund pensions for several individuals in very short order.

Factor in whether you’re on a low salary

Many business owners deliberately draw a low salary to minimise the amount of income charged at the top rate of tax. Previously this limited their ability to aggressively fund a company pension, because the amount you could add was connected to your salary level.

Although it seems you need to draw some salary, a minimal amount evidencing a genuine employment situation is good enough to enable very substantial pension contributions.

What if you have high profits?

It’s become even more attractive to max out on pension contributions if you are enjoying excess profits, or a year of particularly strong trading. Under the old rules, a large pension payment was deductible against corporation tax for companies. But that deduction often required to be spread over several years, limiting its attractiveness. Now, PRSA contributions are fully deductible in the year in which they are paid.

Consider a carryback

It’s long been possible for companies to carry back losses and offset them as relief against tax paid in the prior year. If your company has cash on the balance sheet, and paid corporation tax last year, you may be able to line up a significant tax saving in the company. Large pension payments to key directors and staff could create a loss which is then carried back and set against profits from the previous year.

Time your drawdown

Because it’s possible to hold multiple PRSAs alongside your company pension, the way you take your pension benefits has become a lot more flexible. If you have a single company pension, you can only draw it once, typically on retirement. You’ll take your lump sum, and likely invest the rest.

Now, via PRSAs, it’s possible to set up multiple pension accounts capable of being drawn down at different points in retirement. You might draw down one the day you retire to exploit the tax-free amount of your lump sum. Others you might leave untouched, growing in their tax-free wrapper, before drawing them down at the maximum age of 75.

Think about death benefit and PRSAs

Because we don’t always get to choose the manner of our exit from a business, the treatment of PRSAs in the event of death in service is worth appreciating. If you die while still working, your PRSA funds can be paid in full to your estate.

That’s significantly better than the treatment for occupational pension schemes, where the maximum lump sum paid is based on four times your salary, with the rest used to provide a pension for a spouse or dependents. If you’ve been deliberately drawing a low salary, that could hit your survivors particularly hard.

Factor in the cash on your balance sheet

There’s been much coverage of the small proportion of interest rate rises the Irish banks have passed on to depositors, and despite recent gestures, many businesses will still be receiving near-zero interest rate returns on demand cash deposits.

It’s an obvious opportunity to gain a return. Many businesses sitting on cash deposits have chosen to place the cash in money market funds, a low-risk form of investing which seeks to deliver returns in line with central bank interest rates. The funds remain liquid, and growth is taxed at 25 per cent, less than you’d pay personally via Dirt on your bank interest (assuming you got any).

Protect your shareholding

Remember it’s not all about wealth extraction – you also need to protect the wealth tied up in your business. Run through some scenarios. What would happen if your business partner died? Who would inherit the shares, and would you want to run a business with them?

What would happen if you became unable to work? Could the business continue, and what would the financial impact be? All these risks can be managed, but they need to be anticipated, because by the time they crystallise it’s generally too late to act.

Have your eye on retirement relief

Start with your end in mind. The last great retirement gimme is surely retirement relief, where up to €750,000 of sale proceeds can be had free of capital gains tax on sale of a business if you’re over 55. Again, this relief is a reminder that you need to plan your exit, as it reduces to €500,000 from your 66th birthday.

While many people running a business naturally focus on a big exit, the reality is that steadily extracting money – much of it via pensions – is a lower risk, more controllable way to build up wealth. Do it now while you have the chance.

As part of Pensions Awareness Week 2023, Olive Ryan, Susan Wylie and Gerard Tyrrell will be joining an expert masterclass on pensions for business owners on September 26.

Now in its fifth year, Pensions Awareness Week is an industry-wide initiative which this year runs from September 25 to 29, and which includes workplace visits, webinars and one-to-one consultations to help business owners and individuals get a grip on their pension situation. Find out more at pensionsawarenessweek.ie