Technical: How to borrow safely from pension schemes
6 November 2017
Limits to how much individuals can contribute to pension funds like SIPPs mean the need to borrowing cash for property purchase, for example, has risen.
Martin Tilley, director of Technical Services, Dentons Pension Management looks at the technical issues for scheme members.
With historical reductions in the headline annual allowance and further reductions imposed by the tapered allowance and money purchase annual allowance, it is not as easy to fund a registered pension scheme as quickly as it once was.
As a result, purchase of assets such as commercial property cannot always be afforded outright and this is where pension scheme borrowing comes into play.
Registered money purchase pension schemes have always been able to borrow funds and over time there have been a number of formulas used to calculate the maximum permissible. The current rules have been in effect since 6 April 2006 and are less generous than had been previously available.
The Pensions Tax Manual confirms that scheme trustees may borrow funds for any purpose providing that they or the scheme administrator are satisfied that the borrowing will benefit the scheme and that the borrowing falls within rules laid down by the Department of Work and Pensions. It is a common misconception that borrowing is influenced by or a factor related to the asset to be acquired. In fact, the limit is simply that the maximum aggregate borrowing should not exceed 50% of the net value of the scheme assets immediately before the borrowing is to take place.
As an example, a SIPP with a total value of £200,000 all held in cash deposits could borrow up to £100,000 giving it buying power of £300,000.
Care should be taken when calculating the maximum additional borrowing that can made where the scheme already has some borrowing in place. In these circumstances, the net value of the schemes assets should be calculated taking into account the value of any current borrowing before the 50% limit is set. From this limit, it is then necessary to deduct any current borrowing to determine any additional borrowing that may be available.
An example being a fund holding a commercial property valued at £500,000 with an outstanding debt of £100,000 looking to acquire another property using additional borrowing. The net value of the scheme is £400,000 (£500,000 minus the £100,000 debt). 50% of the net value is £200,000 but from this sum, we must deduct the current debt of £100,000 meaning additional new borrowing of only £100,000 is available.
A further misunderstanding is where a property purchase is subject to VAT. Under pre 6 April 2006 rules, a scheme could borrow the amount of the VAT for a 12-week period on top of the maximum limit. Since then any VAT payable has to be taken into account when calculating the overall borrowing limit.
The test to determine maximum borrowing is at the point the borrowing is taken out and future tests are only undertaken if new or replacement borrowing occurs. There are instances where a current debt might exceed 50% of the current scheme net value. This might be if the original borrowing occurred under a previous, more generous borrowing regime or where the value of assets may have fallen since the borrowing took place. In either situation a remortgage, possibly to obtain better rates might be desirable.
Special considerations might apply in these circumstances. If the debt is to be genuinely restructured, provided there is no increase in the amount borrowed, no test needs to be carried out. A change of lender, increase in the repayment period or change of interest rate on their own would not trigger a test against the 50% limit. The rolling up of interest and capitalisation of that interest would however trigger a test.
Borrowing can be from any source, be it an unconnected third party or a connected party to the scheme but if the latter, the terms of the borrowing must be on commercially available terms.
It is not necessarily a requirement that scheme borrowing be secured, although in practice any third-party lender is almost certain to insist upon the debt being secured with a charge over scheme assets. An example of where security might not be required is where a VAT elected scheme perhaps has sufficient assets to cover the cost of a property purchase but not the VAT element on top. A connected lender might take the decision that the cost of a secured charge is not warranted bearing in mind the debt would be repaid immediately after the VAT paid on purchase was recovered under the scheme’s subsequent VAT return.
Although largely used for asset purchase, borrowing might be necessary for other purposes such as when liquidity is required to pay retirement or death benefits or to transfer to another pension scheme a member’s benefits or an ex spouse’s benefits following a pension sharing order.
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