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Can I borrow from my pension or use it to buy property?

Pensions are predominantly designed to provide you with an income in retirement.  However, if you are a business owner, a SIPP (Self-Invested Personal Pension) or SSAS (Small Self-Administered Scheme) can offer some features that could help your business.

These two types of pension have a number similarities but there are also some subtle differences:

  • Both plans will allow you to purchase a commercial property within the pension wrapper. You can also borrow up to 50% of the pension value to help fund such a purchase
  • A SSAS allows company directors to pool their pensions to give one overall pot, which can have a large effect on the amount of funding available. A SSAS is able to lend money to your company
  • A SIPP is unable to lend to you or your business
  • A common question we are often asked is whether a pension can be used to purchase residential property such as a “buy-to-let”. This is currently not possible – only commercial properties can be held directly within a pension
  • Despite the fact that residential property cannot be purchased, it is possible to buy land for property development. Land or buildings that are being developed or converted to residential property are not classed as residential property until they are deemed suitable as a dwelling.  The property would need to be sold before a habitation certificate is received otherwise very high unauthorised payment charges could be payable

Using your pension for the benefit of your business can be extremely tax efficient but it should be kept in mind that it also means that if there are any problems with your business in future, this could also affect your retirement planning.

However, borrowing within your business can have many benefits.  It could help you to make an acquisition, purchase a premises from which to operate, upgrade machinery or take on a new project to help your business grow.  Clearly you can look to traditional sources of funding for this such as bank loans etc, but your pension offers an additional option that can be highly tax efficient.

How does it work?

A SIPP cannot lend money to your business but it can be used to purchase commercial property from which your business can operate or which you could let to another company.  Your SIPP can borrow up to 50% of its value in order to help fund such a property purchase.

Once the property has been purchased, your pension is the owner of the property and it can lease it back to your business (or any other party) which will then pay rent to the SIPP on commercial terms on a first charge basis.  This means that you cannot buy the property within your pension and then use it for your business free of charge or at a nominal rate, the rent paid must be set at an amount that would be payable on the open market.  However, the rent is tax deductible as a business expense.

The rent is paid by the company into the SIPP and this cash can then be invested into other assets to help diversify the investments and provide a growth and liquidity over the long term

What other benefits are there when buying a property within my pension?

  • Any growth in the value of the property is tax free within the pension. There is no capital gains tax payable on the sale of the property
  • Importantly, the rent paid into the pension is not classed as a pension contribution and therefore does not count towards your annual allowance so you could make additional contributions of up to £40,000 p.a. (or more if you can “carry forward” unused annual allowance from previous years) and these should qualify for full tax relief. This can be a way of increasing the amount that is effectively paid into your pension each year where the company has excess funds that need to be extracted tax efficiently or where pension contributions are limited (for example where the annual allowance taper applies).
  • Although a commercial rent is payable, there are other scenarios where buying property within a SIPP can free up money for your company. For example, if the company already owns the property, a SIPP can be used to buy the property from the company providing the company with cash funds to invest in growth opportunities but also retaining the commercial property from which they operate.  This would count as a sale of the property for capital gains tax (CGT) purposes at the point that it moves into the SIPP and CGT will need to be paid accordingly

What about a SSAS, how is it different to a SIPP?

Like a SIPP, a SSAS can also hold commercial property in the same way as a SIPP and it can also borrow up to 50% of the scheme assets to do so.

A key difference between a SSAS and a SIPP is that a SSAS can also lend money to your company.

A loan from a SSAS can provide an injection of capital which can be used to fund growth opportunities.  It is also often quicker than getting a business loan from a bank and the rate of interest is often lower too without the personal guarantees that are often required with bank loans.  A loan must have the following features:

  • You can only borrow up to 50% of the pension’s net value
  • The loan must be secured as first charge on an acceptable asset. This does not have to be an asset held by the company but must be equivalent to the value of the loan.  Often a company premises is used for this purpose, but equipment or even residential property can be used.  Assets held by the company or those held personally can be used but if the business is unable to meet the loan repayments, the asset would be sold to cover these and this could severely affect the business or you personally depending on the assets used to provide security for the loan
  • The interest rate on the loan must be on commercial terms and set at least 1% above the average base rate of six major lenders
  • The loan term must be five years or less. However, this can be rolled over for a further five years
  • All loans must be repaid in equal instalments of capital and interest

The rules for property purchase or lending within a SIPP or SSAS are very strict so it is important to get advice prior to undertaking such a transaction to ensure that all of these are met.  The charges imposed if the rules are not met are very high and can turn a highly tax efficient investment into an inefficient one even if you breach the rules by accident or without knowing.

What is the process?

Normally setting up a SSAS or a SIPP would involve transferring existing pensions into the new plan.  However, these can also be set up with new contributions paid by you personally or by your company.

With a SSAS, each of the company directors can transfer their existing pensions into the scheme plus any additional contributions and these are then combined to increase the buying/borrowing power.  Each member’s share of the pension is earmarked for their future benefit.  A property can also be held jointly in more than one SIPP.

Although, there are many similarities between a SIPP and a SSAS, in different situations one option may be more suitable or cost effective than the other and we can help to ascertain which is best for your individual circumstances.  We will then also work this into your overall wider long term financial plan to ensure that it will fit in with your longer-term financial goals.

Individual commercial properties can be quite illiquid and this needs to be taken into account as part of the planning when making a purchase.  For example, if the only asset held within a SIPP is a property and this is your only pension, should you need to take some benefits from the pension to provide income or a lump sum there would be no liquid assets to provide this so the property would need to be sold to cover this.  Given this, we would tend to recommend that the rental income is reinvested into a portfolio of liquid assets that is aligned with your attitude to risk so that in the event that a withdrawal is needed, these assets can be sold to cover this.  This also helps to provide diversification outside of the property market as the value of the property will often make up a large percentage of the overall pension value so investing in order asset classes reduces the reliance of your pension on the property over time, reducing risk.

A brief (and simplified) example:

Peter and Sue are joint (50:50) owners of a solicitors, Law Corp Ltd.  They have been in the same offices for a number of years but have recently taken on a number of new clients and have expanded their workforce to provide the resources for the extra work involved.  Although they have managed to make space for all of their staff within the existing offices, conditions are now a bit cramped.  In addition, they have paid rent for over a decade they would like to take the opportunity to be in charge of their own decisions when it comes to their office space.

Peter has recently been made aware that a nearby office which is slightly larger than the existing one has been made available for sale.  It is an attractive property and Peter thinks it would be ideal to provide more space for the existing staff as well as providing additional room for further staff as the company continues to grow.   The seller is keen to release funds as quickly as possible and the property is therefore available at a very competitive price of £600,000 after all costs of purchase.  The business does have some cash holdings of £200,000 which have not been earmarked for any particular use but these are not enough to fund the property purchase.  Peter is keen to extract some of these funds as tax efficiently if possible.  Peter and Sue have looked at the possibility of getting a business loan but wondered if there are any other options available.

Peter describes the situation to his financial adviser at his annual review and he mentions that they could look to buy the property using their pensions.  They have a detailed discussion about all of the pros and cons of buying property within a pension and Peter says he will discuss this option with Sue.

Since starting the company, most of the revenue that they have made has been reinvested to help grow it.  As a result, Peter and Sue have somewhat neglected their own pension savings over recent years.  Peter has built up pension savings of £150,000 whilst Sue has £100,000.  Given this, they don’t believe that they can afford to buy the property.  However, his adviser outlines a plan whereby they could transfer the two existing pensions into a SSAS giving initial funds of £250,000.  Neither of them have made pension contributions in recent years and the adviser suggests making employer’s pension contributions of £75,000 each using their current years’ annual allowance and carrying forward unused allowance from previous years.  These contributions will be received by the pension scheme gross so it is a good way of extracting the money tax efficiently from the company and will increase the combined pension funds to £400,000.  They can then borrow up to 50% of this which would cover the £200,000 shortfall enabling them to raise the £600,000 needed to buy the property.  They would then pay a commercial rent to the SSAS which could be invested into diversifying assets which can be used to cover future needs.  Not only has this enabled them to buy the office space that they need but they have also managed to release some of the cash from the company tax efficiently, leaving enough to cover running costs.

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