Clients often view their pension as a potential source of capital, but borrowing from pension assets is rarely straightforward. Martin Jones, Technical Manager at AJ Bell, looks at the rules around pension lending and highlights the limited circumstances in which pension funds can be used to support borrowing needs.
Clients may need to raise capital for any number of reasons, such as buying a property or injecting capital into a business. Where savings or investments are available, those may be the obvious first places to look.
For many clients, however, their pension may be their largest asset, second only perhaps to their home, so you may find yourself being asked whether pension money can be accessed.
For clients aged 55 or over, pension may be accessible in the usual way. Typically, up to 25 per cent can be taken as a tax-free lump sum, with any income withdrawals taxed as income.
However, a client may not want to crystallise benefits earlier than necessary, particularly if doing so reduces future tax-free cash or disrupts retirement planning.
That would of course be a withdrawal. You might be asked, however, if it’s possible to borrow money from a pension, and this is a question that’s crossed my desk a few times over the years.
Some overseas regimes allow pension loans, including mortgage-style or hardship loans. You might have also come across Lombard lending where a loan is secured against an investment portfolio, so it’s a reasonable question to ask.
Here, we’ll look at what scope there is for borrowing from your pension assets.
Personal pensions
The key point with a personal pension is that it cannot make a loan to the member. The legislation treats loans to members as unauthorised payments, which can trigger significant tax charges for both the member and the scheme.
In practice, trustees and scheme administrators are extremely unlikely to permit such an arrangement.
This is also why clients and advisers should be alert to any suggestion of “pension loans”, “cashback” or “savings advances”.
These phrases have historically been used in pension liberation scams. Even where members were misled, HMRC has pursued unauthorised payment tax charges, leaving some victims facing both the loss of pension funds and a tax liability.
The restriction also extends beyond the member personally. Loans to connected parties, such as spouses, relatives and certain connected companies or trusts can also fall foul of the rules.
A guarantee is also treated in a similar way. A pension scheme cannot be used as collateral for a personal loan, because HMRC views the scheme as taking the same economic risk as if it had lent the money directly.
Loans to unconnected third parties are possible, however. In theory, a registered pension scheme may lend to someone who is neither a member, a sponsoring employer nor connected to either.
However, this is not a routine venture, and genuine third-party lending situations may be few and far between, so it might only be providers at the more bespoke end of the SIPP market that would consider this.
Occupational pensions
The main exception is a loan to the sponsoring employer of an occupational pension scheme. This is expressly permitted, provided the statutory conditions are met. It can apply even where the members are directors or have a controlling interest in the employer.
A SSAS is a small occupational scheme, generally used by directors of small and medium-sized companies. It operates on a pooled basis, so members’ funds are held together and investment decisions are made by the trustees.
Where the business needs funding and conventional borrowing is difficult or expensive, a loan to the sponsoring employer of the SSAS can therefore be attractive.
However, the conditions are strict, and there are five tests for an authorised employer loan: security, interest rate, term of loan, maximum amount and repayment terms.
Broadly, the loan must be properly secured over an asset of the company, charge at least the prescribed minimum rate, last no more than five years, be limited to 50 per cent of the scheme’s net assets, and be repaid in equal instalments of capital and interest.
If one or more of these conditions is breached, an unauthorised payment charge can arise.
It is worth stressing that this is not a way for members to extract money for personal use. The borrower must be the sponsoring employer, and the loan must be a genuine investment of the pension scheme.
If the client’s aim is to inject capital into their trading company, a SSAS loan may be worth exploring, and this is traditionally one of the big selling points of a SSAS.
The key takeaways
In summary, a client cannot borrow from their own SIPP or SSAS, nor can they use pension assets as security for personal borrowing. A SSAS can lend to its sponsoring employer, but only within tightly controlled rules.
For advisers and paraplanners, the key is to identify the client’s real objective early: personal access, business funding and third-party investment are very different questions, with very different pension tax consequences.
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