As companies become more successful, it creates an opportunity to build up positive cash flow. Generally speaking, business owners manage this cash in one of two ways:
- You can draw down an income. Of course you will have to pay income tax at your marginal rate. This means you will get much less into your pocket.
- You can keep this money within your company, pay corporate tax and invest the balance in a low yielding deposit type account.
There is an alternative.
This alternative allows you to extract some or all of your retained profits for your personal benefit. It is an extremely valuable way to fully realise the benefits of your success.
This really is an opportunity not to be missed. I have shown below an example of how this works.
- Director A, 33 years old
- No pension benefits – wants to retire at age 60
- The Company is allowed to pay into a pension for Director A to provide maximum benefits of 2/3rds salary
- Director A currently draws a salary of €100,000 per annum & for ease of calculation we will assume it is his final salary.
- Therefore the maximum annual pension is €66,666 = 2/3rd salary
- Based on the Maximum Contribution rate for his age (this is related to age) Director A can contribute 102% of his salary annually to a pension.
- Director A sets up an Executive Pension Plan and pays a premium from the company account of €8,500 per month or €102,000 per annum. We would recommend a monthly premium as it spreads the investment risk better.
- Based on 6% growth, at 60 Director A’s retirement fund would be worth approximately €5,619,993.
What has been achieved?
- The company gets a tax break of 12.5% on the €102,000 per annum that it pays into the pension,
- The funds grow tax free within the pension fund.
- The Company money is now is now in private ownership
- 25% of the fund value (€1,404,998) is available TAX FREE at retirement.
- €63,500 of the balance has to be invested in an AMRF arrangement assuming you do not have another guaranteed income of at least €12,700 per annum. The Balance of the Fund €4,151,495 can be invested in an ARF arrangement or drawn down straight away if required. An income can be drawn on this if required.
- On death the ARF arrangement forms part of your estate and can be passed on to your next generation.
- Alternatively if the Balance of €4,151,495 was drawn down straight it would be taxed at your higher rate (currently 41%). You would be left with a sum of €2,449,341 after tax.
- In a nutshell your options at retirement would be
OPTION A OPTION B
= €1,404,998 – Tax Free Cash = €1,404,998 – Tax Free Cash
= € 63,500 – AMRF = € 63,500 – AMRF
= €2,449,341 – After Tax Balance = €4,151,495 – ARF
= €3,917,839 – Total = €5,619,993 – Total