Neil Richardson discusses the trend of allowing profits to build within a limited company and ultimately become an alternative form of pension fund in retirement.
At Wesleyan, our specialist financial advisers have always helped dentists project their NHS and private pensions forward to their planned retirement age. This enables them to understand what their future retirement may look like, and what the likelihood is that they will be able to fulfil their dreams and goals, well in advance.
However, this is only one thread of the greater retirement plan. To get the whole picture, we would need to examine every single asset that you have. We could then project what return this would provide you with upon retirement.
At present, one of the most commonly requested themes of financial planning that we receive from dentists is to provide clarity on what the impact would be on their retirement plans if they were to make the transition from NHS to private practise. Specifically, exactly which gaps would need to be filled.
Converting to private practice
For illustrative purposes, let’s take a 40-year-old dentist who is thinking of leaving the NHS to practise private dentistry. This dentist would of course still get their NHS pension at retirement age, having paid into the scheme for years. But they would not have been contributing to it between the age of 40 years until their retirement. This would clearly create an impact on the final pension the dentist would receive. It is something that would require some planning to forecast.
Many dentists find speaking to our experts extremely valuable as they use their experience around pension forecasting and cashflow modelling to demonstrate to dental clients the position they are likely to be in at retirement age. This is based on their current income balance between NHS and private dentistry, and any other planned changes.
As another example, let’s consider a dentist who chooses to leave the NHS service and go fully private. At this stage many dentists seek guidance from an experienced dental specialist accountant and many subsequently decide that they’re going to trade through a limited company to take control of their taxable income and reduce their income tax liability.
Traditionally the input of a specialist financial adviser into drawing wealth tax efficiently from the limited company would then involve setting up pension contributions for the dentist. Potentially also for their spouse if they have a legitimate role within their practice for which they are being paid.
The Annual Allowance
It is fair to say however, that in recent times the Annual Allowance – and until recently the Lifetime Allowance – have been limiting factors in this planning.
Accountants sometimes recommend that their dental clients do not exceed £100,000 of drawings from the limited company. The reason behind this is because once you have taxable income of over £100,000 pounds, your personal tax-free income allowance of £12,570 is withdrawn by £2 for each £1 of income over £100,000.
The impact of this is that if your earnings exceed £125,140, you lose your full personal allowance. This means that you pay tax at approximately 60 pence per pound on your earnings between £100,000 and £125,140. This makes drawing income over £100,000 prohibitively expensive from a tax efficiency perspective.
Therefore, some accountants may advise dentists against drawing anything over £100,000 from the company and to actually defer drawing it out until they reach retirement. This allows the dentist to build a large balance of deferred profit in the limited company and draw it out once they’ve retired or at a time where their income no longer exceeds this £100,000 threshold.
The impact of this for the dentist is the potential prospect of paying less tax than they would have had they drawn the funds out earlier.
Specialist advice
A specialist financial adviser can help in this type of scenario by using their unique understanding of the dental industry to discuss the client’s future objectives with them. This encompasses both the business aspect as well as the dental career pathway.
If it is appropriate for the dentists individual circumstances and plans, and if pension planning is being maximised, they could then consider the prospect of investing the money held in the limited company to make that money grow, so that when they do retire, it becomes a source of capital within the limited company which could be withdrawn over many years post-retirement – almost as a form of alternative pension.
A common question posed by dentists is: ‘Why would I invest this spare capital held in the limited company?’
The simple answer to this is that while recent high inflation has pushed interest rates higher than we have experienced for a long time, many limited company bank accounts are still offering very low, or even no interest at all.
Diverse future planning
We have all seen the impact of inflation on both our personal cost of living, and the same is true of the expenses of dental businesses. This high inflation has the same impact on our saved capital. If the rate of return you are receiving is lower than the rate of inflation, the impact effectively devalues the future spending power of that money. Therefore, if the money were to be invested instead, it could potentially deliver a higher level of growth that buffers the impact of inflation.
In short, we are seeing dentists plan for their future in ever more diverse ways as the profession, legislation and taxation change. The value of planning early in your career for what you do later in life has never been higher due to the ever-changing landscape. Having a specialist team to help to guide you is crucial to ensure that you are not only running your business effectively but are also maximising the profit it is creating.
We all have to remember that our future selves are relying on us to make good decisions in the present. These will allow us to have retirement options and indeed choices regarding what we can do during our retirement.
You can book a no-obligation financial review with a specialist financial adviser to discuss alternative pension funds for your retirement. Visit www.wesleyan.co.uk/lifes-journey or call 0800 316 3784.
Please note: Tax treatment depends on individual circumstances and may be subject to change in future. Bear in mind that the value of investments can go down as well as up and you may get back less than you invest.
