Adam Tavener, chairman of Clifton Asset Management, which advises clients on using their pension as collateral when making investments, known as pension-led funding, said current safeguards for those wanting to use their nest eggs to invest in a business were "not adequate".
He said it was important Tpas, as one of the main providers of the government's guidance guarantee Pension Wise, acted as a first barrier for people wanting to withdraw their funds to invest in their business, which is likely to trigger a tax charge.
Mr Tavener said: "We don’t think the safeguards currently in place for people wanting to use their pension to invest in a business are adequate, but this is not a regulatory issue, it’s a guidance issue.
"Whilst we congratulate Pension Wise on the work they do for most of their customers, we do feel that the journey concerning those enquiries that may be anticipating using their pension money to fund a new or existing business needs to be improved."
He said there should be a process of identifying this group of people and informing them that cashing in their pension and taking the tax consequences wasn't the most sensible way of doing this.
"There are other ways of funding a business without destroying the pension," he said.
There are two main types of pension-led funding: commercial loans and unlisted share investment:
A commercial loan from a pension is where a business borrows money from the pension, and pays it back with interest and is available via a small self-administered scheme (Ssas) with trustee approval.
For an unlisted share investment, available via a self-invested personal pension (Sipp), savers can use up to 70 per cent of their pension scheme value to invest in either an ordinary unlisted share investment, or preference share investment.
Michelle Cracknell, chief executive of Tpas, which runs the Pension Wise information service, told BBC Radio 4 on 9 January it was important for pensioners to understand there were ways around incurring big tax charges where pensions are used to fund a business.
She said: “One of the issues which we have picked up on [at Pension Wise] is that a number of people think they have to take their money out of the pension fund to invest in the business, but you can actually use your pension fund, with all of the tax advantages involved, to either do loans or buy properties for your business to run from, and that’s why it’s so important to get advice.”
But Mr Tavener said the issue lay with the guidance providers.
Using pension funds to back new business has been a growing trend following the pension freedoms.
Research cited by the BBC indicated the start-up market was undergoing a boom, with 600,000 new businesses registered in the past year alone.
A separate survey conducted by insurer Axa in April 2015, when pension freedom was introduced, found one in 10 over-55s due to retire in the following 18 months were considering using their pension savings to help start a small business or a consultancy, FT Adviser’s sister title Financial Times reported at the time.
Since the freedoms, people have been able to access their pension cash subject to their marginal rate of income tax, which is levied on all but the first 25 per cent they withdraw.
But they can also use a small self-administered scheme (Ssas) or a self-invested personal pension (Sipp) to make a commercial loan or to buy commercial property.
Any interest on such a loan or any rent payable on the property would then go back to the pension as opposed to another lender such as a bank.
Mr Tavener said one of the most important things to consider when funding a business with a pension was the quality of the underlying business plan.
“The nightmare scenario is when these things become more commonplace to do and people are accessing their pensions through the pension freedom regulations without taking appropriate advice as to the wisdom of putting that money into a small business,” Mr Tavener said.
Clifton advises the maximum advance from a Sipp should not exceed 60 per cent under normal circumstances and 65 per cent for certain exceptions, while regulation dictates a Ssas loan must not exceed 50 per cent.
To make it commercially viable, the pension fund should have accumulated at least £50,000, he said.
Dobson and Hodge financial services director Paul Stocks said he was once asked by a client to set up a £200,000 pension-led funding structure with a Ssas but the cost involved became "prohibitive".
“Whilst the will was there when we set it up the cost from legal, administration and so on quickly snowballed,” he said.
“I don’t see it as a mainstream thing, it would probably work for sums closer to £1m. I would suspect it’s harder to lend money from your pension than to get it from your bank.”
Nevertheless, he said there was a place for the products in today’s market.
“Where we see it working well is buying property for your business and becoming your own tenant but obviously the risk is still there if the business goes belly up,” he said.
carmen.reichman@ft.com
