Many a slip twixt loan and Sipp
Clients want investment flexibility but Sipp members must be aware of the risks associated with a loan
Many advisers have clients who are looking for investment flexibility and alternatives to traditional stockmarket or fund-based investments.
One option for these advisers is to look at the investment options available within a pension fund and, in particular, Sipps. Although not all Sipp providers allow investment in the full range of permitted investments, a number of bespoke Sipp providers do allow both borrowing and lending within their Sipp products.
These additional investment options can be attractive to those with more sophisticated investment needs.
Traditionally, borrowing has been used to assist in the purchase of commercial property within a Sipp. Although the 2006 A-Day changes brought a reduction in the maximum borrowing limit, more flexibility was introduced. There is no longer a requirement for borrowing to take place to support the purchase of a commercial property. Borr-owing is now permitted for any investment purpose. Clearly, gearing a pension fund increases risk but, for the right client, the ability to borrow funds can be an important flexible feature. Sipps can now borrow up to 50 per cent of the net value of the Sipp. So, a Sipp with a value of £100,000 can borrow funds of up to £50,000.
If a borrowing opportunity is identified, it is usually the responsibility of the adviser and/or client to identify the lender, confirm the terms of the borrowing and whether any security is to be taken. The borrowing will be taken out by the Sipp trustee. It is important for advisers to think ahead to ensure that future cashflows will be sufficient to meet repayments.
HMRC rules permit Sipps to make loans to third parties, provided they are prudent, secure and on commercial terms. However, loans to members (or those connected to members) are not permitted and any such loans made will be taxed as an unauthorised payment. This differs from SSASs, where loans to employers are permitted.
As HMRC requires that any loans made to unconnected third parties are prudent, Sipp providers tend to only allow a proportion of the total value of a Sipp to be inves-ted in loans to third parties. Many bespoke Sipp providers only allow loans to be made to corporate institutions loans to individuals are not permitted.
Given the HMRC requirement that loans are made on a commercial basis, Sipp providers will seek confirmation that the terms of the loan are similar to those available from a third-party bank.
Although the loan must be “secure”, there is no formal requirement for security to be taken. It is for the adviser and client to decide whether they want to take security. However, care needs to be taken on the form of security taken as serious tax consequences could arise in the event of a default.
If security is to be taken, it may be necessary for a solicitor to be appointed to deal with taking the appropriate legal charge over the asset offered as security. The solicitor will be appointed to represent the Sipp trustee, as the formal lender. The solicitor’s fees will need to be met by the Sipp.
It is important that the Sipp member is fully aware of the risks associated with a loan. Given the risks, loans will remain a niche investment opportunity for sophisticated investors. If the borrower defaults on repayments then the entire value of the loan, including outstanding interest, could be lost.