The ability of pension schemes to borrow is set to become more restricted as a result of this year's Finance Bill and, with only 22 months left until the new rules take effect, action needs to be taken soon.
Current rules for self-invested personal pensions allow borrowing of up to 75 per cent of the purchase price to invest in commercial property. In practice, banks tend to be more circumspect and limit loans to nearer 70 per cent of any bricks and mortar offered as security.
The new rules are much more restrictive for most Sipps, limiting borrowing to 50 per cent of scheme assets for any new loans on or after April 6, 2006. Existing borrowing must be deducted in calculating the maximum figure.
Take an imaginary company, Acme Widgets, whose managing director John White has a Sipp. White is considering moving the business to bigger premises although he wants his Sipp to keep the property it already owns and let it out. The Sipp currently owns commercial property valued at £300,000, against which it has borrowed £150,000, and also has £150,000 in cash.
Under current rules, White could use the £150,000 cash as a 25 per cent down payment on the new property and borrow another 75 per cent of the purchase price. This would allow him to buy a property valued at up to £600,000. Even if the bank will only lend 70 per cent of the valuation, he still has £500,000 to spend.
But the new rules change the picture significantly by allowing total borrowing of only 50 per cent of the Sipp assets or an additional £75,000. This is calculated by adding up the value of the Sipp assets (cash and property) which total £450,000, then dividing by two (£225,000) and deducting existing borrowing (£150,000).
So White has only £150,000 in cash and £75,000 in new borrowing – a total of £225,000 – to buy a new property. This is unlikely to be enough to fulfil his wishes and move his business to a bigger home.
Small self-administered schemes face a similar dilemma although in most cases the difference before and after April 2006 is likely to be less marked.
The current rules allow a SSAS to borrow up to 45 per cent of the scheme assets plus three times the ordinary annual contribution. In most cases, this is not too far removed from the new 50 per cent of scheme assets rule but schemes with big annual contributions may want to consider doing something sooner rather than later.
But the new rules are not all bad news as there are some interesting aspects that could come in useful. One of these is the amount that can be paid in as a contribution. Personal contributions up to the higher of £3,600 a year or 100 per cent of taxable earned income will be allowed, together with unlimited employer contributions.
Although employer contributions are unlimited in theory, it is unlikely that employers will pay an annual contribution for any individual that exceeds the annual allowance (£215,000 in 2006/07) as any excess over the annual allowance is taxed on the member at 40 per cent.
The facility to make big contributions will make it easier to build a pension fund quickly and borrow more on the strength of that fund.
Taking again the example of White, a gross employer contribution of £190,000 – on which the business receives tax relief – would boost the cash in the scheme to £340,000. This contribution also increases the assets of the scheme from £450,000 to £640,000 and hence the amount that can be borrowed from £75,000 to £170,000, representing half the new scheme assets less existing borrowing of £150,000.
The Sipp now has £510,000 to spend when it adds its cash and borrowing together. This is about the same as it realistically has at present (£500,000) if, as noted earlier, a lender is prepared to advance only 70 per cent of the property value.
Another change that may help schemes that want to borrow is what can be counted as a scheme asset for borrowing purposes. Certain pensions in payment can be counted but others cannot. Any money-purchase scheme will have the opportunity to pay an income at retirement to a scheme member in one of four ways:
As a scheme pension.
As a lifetime annuity.
As an unsecured pension (drawdown up to 75).
As an alternatively secured pension (drawdown after 75).
In calculating the value of the assets to be used to justify borrowing, the following can be included:
The value of uncrystallised rights – these are funds held which have not yet been used to provide an income and are valued at market value.
The value of any assets used to support the member's or dependants' unsecured or alternatively secured pensions – this is the member or dependants' drawdown fund and is again valued at market value.
The value of any scheme pension (but not a lifetime annuity) in payment – this is valued at 20 times the amount of pension in payment.
It is obviously more advantageous from a borrowing point of view to buy a scheme pension than a lifetime annuity.
This could be useful in a family SSAS, with the younger members borrowing to buy business premises but with borrowing based on the value of pensions in payment to older family members as well as the value of the funds belonging to younger members.
It has not gone unnoticed that pension schemes will be able to own residential property in the not too distant future. An obvious question might be: “Can my pension scheme borrow under the current more generous rules before April 5, 2006 and then use this money to buy residential property after April 5, 2006?” Unfortunately, the answer is no. For Sipps, the answer is clear cut and they can only borrow for the purpose of buying commercial property until April 5, 2006. But it is not as obvious for SSASs. Although SSAS rules do not insist that borrowing must be used to fund commercial property purchase, the amount borrowed must be calculated at the date of asset purchase. As residential property can only be bought after April 5, 2006, borrowing must be calculated on the new definition.
For any business thinking about moving premises or sophisticated investors wishing to invest in commercial property tax-efficiently, buying through a pension may be advantageous. But if they need to get a loan, make them aware that they are living on borrowed time.