Partnership: What Will It Mean For Your Personal Finances?
Being made a partner is a career ambition for thousands of legal professionals across the UK. It is a significant achievement and a milestone to celebrate – but certainly doesn’t come without adjustment.
Neil Messenger, Director of Client Markets at 1825, explains what being made a partner could mean for your personal finances.
By taking on this new position, there will be a whole host of changes. But on top of that, new partners mustn’t overlook the financial implications that their new role brings.
With greater responsibility comes the potential for greater financial liabilities. By stepping up to become a partner, individuals may make the shift from being a salaried employee to being self-employed and owning a stake in their business – bringing changes to how they’re paid, their pension and their tax liabilities, and making their financial and work lives more intertwined as a result.
One of the biggest financial changes for new partners is the way in which they are paid, and therefore how much tax they are liable for. These individuals will now be viewed as self-employed so taxed as a sole trader, even though their partnership will usually handle tax returns and payments. However, tax and national insurance are still a personal responsibility.
The tax liabilities owed by an individual will likely depend on the type of partner an individual is. Typically, there are three different levels: salaried partner, fixed-share equity partner and full equity partner:
- Despite being known externally as a partner, a ‘salaried partner’ will remain on the payroll as an employee with a fixed salary, meaning their finances and the tax they are liable for is much easier to predict.
- A ‘fixed-share partner’, whilst being self-employed, usually receives a guaranteed fixed profit share and therefore a predictable income.
- A ‘full equity partner’ will normally receive a fixed monthly income, drawn as an advance against future profits, but beware, in these unpredictable times if future profits are down you may have to repay some of this money.
Whilst full equity partners usually earn more, this doesn’t come without risk. A robust financial plan is important to build security outside of the business and mitigate those risks. Speaking to a tax planner or financial adviser will allow new partners to fully understand their tax liabilities and how best to prepare for any difficulties when their income may be unpredictable.
What it means for a partner’s pension
After an employee becomes a partner, they will no longer be eligible for their company’s pension scheme. Instead, partners must start their own private pension or, if the firm offers a partners pension, they can enter that. But the bottom line is that, by leaving the company pension scheme, a new partner gives up their employer contribution – which can be as much as 10% for older, salaried employees. With partners now responsible for making their own contributions, without the additional top-up provided by the employer, individuals can see their contributions tail off.
It will be important that partners continue to save as much as they can into their pension. However, higher earners may have their contributions limited by taper rules on tax relief, which could reduce how much they can pay into their pot to £10,000 a year – a figure that partners could hit or even exceed without noticing. Because the rules around a partner’s pension contributions apply to total income, it can be especially difficult to assess how much can be made in the way of pension savings until the end of the year. A professional adviser can help a partner understand their pension limits, and plan to ensure they’re maximising the growth and value of their retirement savings.
Many companies will aim to instil good governance for their partners’ finances by contractually requiring that partners have an updated will and estate plan in place within their first year. However, there are still risks associated with becoming a partner and protecting one’s assets.
In extreme cases, a partner’s personal assets – including their home – may be liable to practice debts, should the firm enter financial difficulties. If there are insufficient funds in the partnership to cover the liabilities, creditors can pursue the individual partners. A common way to limit the impact that a firm’s potential financial difficulties might have on a partner is to hold assets in trusts, a limited company, or in the name of another close family member. However, this can leave partners without any assets to their name, so it is important to strike a balance.
Once a partner reaches retirement, it’s common to receive a guarantee from the ongoing partnership against any future claims against the business, but this is not the case in all situations. It is therefore important that partners make sure they understand their specific contractual stipulations pre-retirement.
It’s easy to find a change in your financial situation overwhelming when becoming a partner, particularly in the first year of a partnership, but this is where financial advisers can play a key role. They can ensure that everything has been considered when it comes to your finances and will help you take the necessary steps to limit any future financial difficulty.