Ssas have numerous powerful options that many other pensions do not. Pooled investments for a small group of connected people can mean bigger and better buying power for both investments and commercial property. But one of the special powers that a Ssas has is the ability to lend money to its sponsoring employer. These are called loan backs, or authorised employer loans in HMRC terminology.
When a Ssas is established it needs to have a sponsoring employer, although all the members are not required to work for this employer. This makes it possible for a small firm to have a pension scheme that could have significant funds brought in from family members, as well as the executive team.
Technically, they don’t need to be family members, but as the funds are usually invested as a whole there really needs to be some connection and common goal between the members in the scheme.
In the current economic climate, even financially sound companies may find it difficult to arrange finance via the traditional route of their local bank. However, it is possible for a Ssas to make a loan to its sponsoring employer called a loan back. This can be of great benefit to an employer, especially as the interest rate charged need only be 1 per cent over the average base rate of the six main UK clearing banks.
Even if a Ssas is not already in place, it may be a reason for consolidating existing personal pensions or self-invested personal pensions (Sipps) into a Ssas to allow an immediate loan back of up to 50 per cent of the fund value.
It should be noted that since HMRC changed the way in which Ssas are registered, there can be a delay in setting up a new Ssas, so this may not be the quick fix it used to be. But because HMRC is taking a greater interest in the establishment of Ssas, the change will remove the temptation of scammers to use these to gain access to people pension funds. Currently, the establishment of a new Ssas can take up to six months, but by the same token it can also be quicker than this.
There are strict conditions that need to be adhered to if the loan is to be treated as an authorised employer payment and avoid any adverse tax consequences. There is no point in doing a loan back if any of these conditions can’t be met: the tax charges could completely wipe out any benefit of a Ssas and even result in deregistration should the issues be that significant. This is why a loan back should never be used to prop up a failing business, because not only could the company fail but the pension could be lost with it.
Loan-back conditions
As mentioned above, a loan back can only be made from certain occupational pension schemes to their sponsoring employers. In practice, this will mean they can only be made from a Ssas because a Sipp is not occupational and therefore doesn’t have a sponsoring employer, even if there is an employer paying contributions.
Since A-Day (6 April 2006) it has been possible to make such a loan for any purpose, and this offers greater flexibility than was previously the case. A-Day also saw the end to all rules relating to how long a scheme had to be established before a loan back could be made. This means that an individual can, for example, transfer a number of personal pension arrangements into a Ssas with the Ssas fund being available immediately to justify a loan back to the sponsoring employer.
HMRC sets out five criteria that all need to be met for a loan back from a Ssas to be treated as an authorised employer loan:
Security
The loan must be secured as a first charge on assets that are at least equal in value to the loan plus the interest due over its term. Subsequent falls in the value of the security are permitted, provided these are not the result of actions taken by the employer or connected persons. The charge must take priority over any other charge on the assets.
Where a charge is taken over company-owned assets this must be registered with Companies House within 21 days. What these assets are isn’t necessarily an issue, but it should be borne in mind that the asset could be claimed by the Ssas or need to be sold should the loan not be repaid. If the Ssas placed security on a residential property, then it wouldn’t be able to take that into the scheme if the loan isn’t repaid – it would need to be sold, which might prove a serious issue for the resident.
Interest rate
The loan must have a minimum interest rate equal to the average of the base lending rates of the six leading high street banks, plus 1 per cent. Where the average is a multiple of 0.25 per cent, this will be the rate. Where it is not such a multiple the average should be rounded up to the next multiple of 0.25 per cent.
HMRC is happy for a loan to be established using a fixed rate of interest, and as long as the terms of a loan remain unchanged there is no requirement to alter the interest charged on a loan during its life. This is the minimum rate but a higher rate could be applied. A higher rate isn’t likely to benefit the company, only the pension. This could be an issue should there be a problem with repaying.
Term
The loan must be for a maximum term of five years. The total amount owing (including interest) must be repaid by the loan repayment date. It is therefore entirely a matter for the trustees to decide when a loan should be repaid, subject to the five-year limit, having regard to the likelihood of paying retirement benefits at some future date.
The term doesn’t need to be determined by the member’s planned retirement date, but if there aren’t sufficient funds to pay benefits at the time they want to retire they can’t just recall the loan to be repaid.
Value
It must be no more than 50 per cent of the market value of scheme assets at the date the money is loaned to the employer. This limit is not retested subsequently if there is a fall in the value of the scheme’s assets unless the terms of the loan are changed. Any further loan advances to the employer are treated as a new loan and the 50 per cent limit is retested at that time.
Repayments
Finally, the loan must be repaid by equal instalments of capital and interest for each complete year of the loan. There is also only one opportunity for schemes to roll over a loan – that is, where there are amounts owing on the fifth anniversary – and only then for a maximum extension period of five years. This allows a loan to be extended where the sponsoring employer is having genuine difficulties making repayments, without having to find replacement security for the loan if the original security has fallen in value.
Uses of loan backs
There are a number of circumstances where such a loan back might be attractive. The minimum interest rate payable to a Ssas may be very competitive compared with interest rates available from a bank in the open market. An employer may also be otherwise unable to obtain a loan on the open market.
Another situation would be a case where a Ssas already has an authorised employer loan with an interest rate much higher than would need to be charged. It may be worth considering repaying this loan and immediately taking out a new loan at the current lower rate of interest.
The rate of interest of base plus 1 per cent is the minimum. The charging of a higher rate of interest than the minimum could provide an attractive investment for the Ssas, as well as much-needed cash for the scheme’s sponsoring employer. However, this higher rate would have to be shown as a commercial rate of interest if an unauthorised payment charge is to be avoided. As there will be a loan agreement in place, setting a rate too high could also cause problems and could lead to the company defaulting.
Firms that may be reluctant to make a pension contribution now due to future cash flow fears can make a contribution and borrow 50 per cent of total scheme assets back immediately.
Ssas and loan backs still have a place in good pension planning for sound companies. They have been poorly marketed in recent years as a way to simply raise cash that wasn’t really required or to prop up a failing company.
As with all pension planning, the purpose of the pension is to provide an income in retirement, so if the loan is bad planning for the pension it shouldn’t be considered.
Claire Trott is head of pensions strategy at Technical Connection
