Pension loan backs present a fantastic financial planning opportunity to temporality release money from the pensions of business owners to help grow the business or help during tough times.
A SSAS pension loan back scheme is a legitimate way of releasing money within your pension scheme in the form of a loan to be paid back. If this is something you would be interested in learning more about, speak to one of our financial advisors.
Below, I will take you through an imaginary case study to show how this works in practice.
Case Study;
David and Rose have a successful limited company. They are looking to grow their business and like many other small to medium sized companies, they may be reluctant to get a commercial loan. In these circumstances they may be able to borrow money from their pension fund instead.
Both have a number of small personal pensions, after seeking financial advice they decide to transfer their personal pensions into a joint Small Self-Administered Pension Scheme (SSAS). Once all the pensions have been transferred, the value of the SSAS stands at £300,000 with a 50/50 equal split of the value.
When the SSAS is set up, their limited company is the sponsoring employer of the scheme.
Can They Make a Loan to their Company?
The HMRC will allow this as long as 5 key criteria are met:
- Maximum amount of loan
- Term of loan
- Interest rates
- Security
- Repayment of loan
If the loan fails to meet any of the above criteria it will be deemed as an unauthorised pension payment and will be subject to tax penalties.
We will now look at the criteria individually.
Maximum amount of loan
As the SSAS is new and made up from transferred personal pensions, the maximum amount of a loan which can be made to a sponsoring employer is 50% of the total value of the new SSAS. In this case, since the SSAS is valued at £300,000 – the maximum loan is £150,000. The amount may be lower for an existing SSAS is the scheme already owned commercial property for example.
The knowledge of knowing they can lend £150,000 is an advantage, as this loan amount is likely to be significantly higher than what most high street banks will lend to a small business.
The date the money is lent is when the value of the SSAS is calculated, so should the value of any investments within the SSAS fall then so will the amount they can loan. By speaking to one of our financial advisors, we can give an early indication of the likely loan amount.
Term of loan
The repayment term of the loan must not exceed 5 years from the date the money is lent. If the sponsoring employer runs into financial difficulties during the term, the outstanding balance (including interest) can be rolled over for a further 5 years once.
Interest Rates
The rate charged must be at a commercial rate calculated at 1% above the average base lending rate of the 6 leading high street banks (Barclays, HSBC, Natwest, RBS, Lloyds, and Bank of Scotland).
1% above this rate is usually lower than the high street banks normally charge making a SSAS loan more attractive than a bank loan. The rate of interest that can be charged can be fixed which means that even if the base lending rate changes then the terms of the SSAS loan stay the same from the outset.
Security
The loan to the sponsoring employer must be secured as a first charge of against an asset. This asset does not need be owned by the sponsoring employer but does need to be equal to the amount of the loan.
Usually property is used as security against the loan. Company business premises could be used if it has an appropriate valuation and no other charges against it. Commercial property is usually the most efficient form of security.
Repayment of loan
The loan is repayable in equal instalments of capital and interest.
For example, if David and Rose decide to borrow £150,000 charged at fixed rate of 3% compounded over 5 years, the total amount that will need to be paid would be £173,891.
The amount repayable at the end of each year is;
Year one [(£150,000 + £23,891)/5] x 1 = £34,778.20
Year two [(£150,000 + £23,891)/5] x 2 = £69,556.40
Year three [(£150,000 + £23,891)/5] x 3 = £104,334.60
Year four [(£150,000 + £23,891)/5] x 4 = £139,112.80
Year five [(£150,000 + £23,891)/5] x 5 = £173,891
Therefore, in accordance with the loan agreement, the repayable amount each year would be £34,778.20
Risks
If the sponsoring employer defaults on the loan, the security held will need to be sold to provide the necessary capital to repay the loan. This could cause problems to the business if company owned commercial property is used as security.
There could be issues if David and Rose reach retirement age and want to access their pension before the loan is repaid in full.
Repayments made by the company will be classed as a business expense, it will therefore reduce corporation tax liability. The SSAS itself will be receiving funds and interest in to scheme ready to provide an increased value for retirement. It is potentially a tax efficient way of taking money out of the business and growing the pension fund. However, as low interest rates are usually charged on loans, the scheme might achieve a higher value if invested for the same period.
This guide was written by Craig Croft-Rayner, an independent financial advisor at Milestone Financial Planning. It is a for guidance only and is not in of itself financial advice. Should any of the above apply to you, please get in touch for a consultation at no c0st.