Can your client borrow money from their SIPP or SSAS?
There are various situations where a client may be looking to raise funds, whether it’s making a one-off property investment, paying for a large family event or injecting cash into a business.
This is particularly true under the current COVID-19 conditions where, for some clients, the more traditional sources of income, such as employment and investments, are possibly at lower levels than in previous years.
Pensions are, of course, one potential source of funds.
Clients aged 55 or over can access lump sums – either through tax-free cash or an UFPLS – and receive income in the form of drawdown, annuities and defined benefit scheme pensions.
Clients who are under 55, however, and those who are unwilling to take pension benefits for planning reasons, may enquire instead whether there is any possibility to borrow money from their pensions.
This happens elsewhere in the world, with some pension schemes in the US and Australia able to make loans to members in certain situations, usually linked to significant financial hardship.
However, loans tend not to enter the standard discourse on pensions and financial planning in the UK.
So, in this article, we’ll be looking at if, when and how clients can take loans from their pensions, particularly with regard to Self-Invested Personal Pensions (SIPPs) and Small Self-Administered Schemes (SSASs).
We’ll also be looking at the potential pitfalls and tax charges that might apply, given this is an area fraught with complexity.
SIPP – loans to the member or to a ‘connected party’
Firstly, let’s look at whether a client can take a loan directly from their SIPP.
The legislation is clear that a loan from a personal pension scheme to a member is an unauthorised payment. This means it would incur tax charges of at least 40% of the value of the loan. The tax charges would fall on the member personally.
If a scheme were willingly allowing unauthorised payments of this nature, it would invite unwanted scrutiny from HMRC.
And if HMRC perceived there to be systematic abuse of the pensions tax regime, it has the power to deregister a pension, which would have a significant impact on all members of the scheme.
Therefore, it’s unlikely that any reputable provider or administrator would agree to facilitate loans to a member.
It’s important to note that this rule applies not only to members, but also to persons or companies ‘connected’ to the member.
For the definition of ‘connected’, the pensions legislation points you in the direction of section 993 of the Income Tax Act 2007. This is too lengthy to reproduce in full, but in broad terms it means spouses, civil partners and relatives. (It also extends to relatives of spouses and civil partners as well as spouses and civil partners of relatives.) Connected companies are those that the member is a director of.
Also worth noting is that the definition of a loan includes loan guarantees. Therefore, a SIPP cannot be used as collateral for a loan.
SIPP – loans to ‘unconnected parties’
There is a bit more scope, at least as far as the rules are concerned, for a personal pension to make a loan to a person or company that is not connected to the member. This is not listed as an unauthorised payment in legislation.
In practical terms, an ‘unconnected party’ could be, for example, someone like a friend, colleague or maybe a business partner.
However, it’s quite possible that most pension providers won’t have come across this, given it’s arguably not a situation that takes place too often in real life. The friend is more likely to look to other sources, or the client would be more likely to use non-pension funds.
Therefore, if a client did want to go down that route, they would need to find a provider comfortable with facilitating it. They would almost certainly be looking at the more bespoke (and costly) end of the SIPP market for this.
Also, taking a detached, commercial view, a reasonable member might be unwilling to lend money to a third-party from their pension, potentially jeopardising their own financial security in retirement.
Then again, during a period of low investment returns, that might seem like a way of making returns above current cash interest rates.
SSAS – loans to a sponsoring employer
The biggest scope for pension loans comes with an occupational pension scheme such as a SSAS, and this is the area we will focus on most in this article.
Despite a sponsoring employer being ‘connected’ to the scheme, pensions legislation allows a SSAS to make loans to the sponsoring employer. This is a big selling point of a SSAS, and employer loans are something that occur relatively frequently.
(Note that a loan from an occupational pension scheme to a member is still an unauthorised payment.)
For a loan from a SSAS to a sponsoring employer to be an authorised payment, it must meet five conditions. These relate to:
- the amount of the loan;
- the term of the loan;
- the interest rate;
- the repayment terms; and
- the security.
If a loan fails on one of these conditions, there will be an unauthorised payment. However, the amount of the unauthorised payment is not the value of the loan.
Instead, it depends on which condition is not met, and each condition has its own calculation in terms of attributing a value to the unauthorised payment.
If two or more conditions are not met, the amount of the unauthorised payment is determined by whichever failed condition produces the highest unauthorised payment.
Let’s look at these conditions in a bit more detail.
Amount of loan
A loan must not be more than 50% of the net asset value of the scheme. This is assessed at the point immediately before the loan is made.
This is a one-off test. If the net asset value later drops such that the outstanding loan amount comes to more than 50%, it will not create an unauthorised payment.
However, if the scheme makes a further loan, there is a further test of the 50% limit. This takes into consideration outstanding loan amounts and the net asset value at that time.
If the 50% limit is breached, the unauthorised payment amount will be the difference between the total value of the loan(s) and 50% of the net asset value.
Term of the loan
The term of the loan must not be longer than five years from the date of the loan.
However, if a sponsoring employer faces financial difficulties, the legislation allows the SSAS to roll the loan over for a further five years.
Where a rollover takes place, the terms of the original loan must stay the same. The rolled over loan will not be treated as a new loan, so it will not need to be tested against the 50% limit, and any existing security can continue to be used.
If the term exceeds five years, the unauthorised payment amount is calculated by dividing the loan amount across the number of days in the term then applying that pro rata against the number of days by which the term exceeds five years.
The SSAS must charge interest on the loan of at least 1% above a specified interest rate. This is to ensure a commercial rate of interest is being applied to the loan.
The specified rate of interest is based on the lending rates of six leading high street banks rounded up to the nearest 0.25%.
Helpfully, HMRC publishes the rate on this web page under the heading ‘Other Corporation Tax Self-Assessment interest rates – Interest charged on underpaid quarterly instalment payments’.
If the interest rate is lower than the prescribed rate, the unauthorised payment is calculated by applying the shortfall on a percentage basis to the loan amount. For example, if the rate used is 10% lower than the prescribed rate, the unauthorised payment is 10% of the loan.
The loan must be repayable in at least equal instalments of capital and interest. It must also be payable at least annually. This means that one fifth of the capital and interest must be repayable as a minimum by the end of year one, two fifths by the end of year two and so on.
Here, it’s important to point out that this requirement is about how the loan repayment terms are documented at the outset. It’s not about how the repayments are actually made. When it comes to the payments, employers can frontload them or even repay loans early.
If a sponsoring employer is unable to keep up with the repayment terms, it’s important that the repayments are pursued by the SSAS on a commercial arm’s-length basis to reduce the chances that HMRC decides an unauthorised payment has occurred.
If the repayment terms do not meet the minimum required amount, the unauthorised payment amount is calculated as the difference between these two figures in whichever loan year provides the biggest difference.
The value of the loan must be secured over the full term of the loan on a first-charge basis on any asset owned by either the sponsoring employer or another party.
The security must be valued at least equal to the face value of the loan (including interest) and there can be no other charge on the asset that takes priority over the charge made by the SSAS.
If the asset used as security is ‘taxable property’, such as moveable machinery, there may be additional tax charges, meaning most scheme administrators will not permit taxable property to be used as security against the loan.
If this condition is not met, the unauthorised payment is the difference between the value of the security and the amount of outstanding loan.