Now more than ever we will all be seeing clients who face challenges in funding and supporting their own business. These clients may have used the various support schemes already and may face further need to secure funding.
Pensions are always a popular source of consideration and with other government options exhausted, they may be a number of people’s last resorts to providing essential funding to their own business.
Every case has to be assessed on its own merits as to whether using a pension fund is suitable for this objective but if it were, what options do businesses have? There are four main options available with each offering different advantages and disadvantages and each being more or less suitable to certain scenarios.
To summarise these before going into detail, these are:
- Flexible access of a pension plan
- Loaning funds from a pension to a business
- Using pension funds to purchase property from the business
- Using borrowing within a pension to provide funding for all the above
Flexibly accessing a pension plan
This will be the easiest option and something a client might come to an adviser with the idea of doing. Using the PCLS entitlement will be the most attractive option in providing a source of capital that is not further debt and compared to most other options, cheap.
Care should be taken if taxable income is taken in this scenario, as the triggering of the Money Purchase Annual Allowance (MPAA) and reduction in annual allowance could have severe funding implications for the future, which will be more important the further the distance from retirement the client is.
Another limitation of this method is the depletion of personal retirement funds and the loss of access to PCLS for retirement purposes. The reduction in fund value by withdrawing a portion of the pension could also impact on the potential fund accumulated by retirement which could in turn impact on possible retirement plans.
Loaning funds from a pension to a business
The first of the slightly less used options and probably one that a number of clients will not know about.
This works by setting up a Small Self-Administered Scheme (SSAS) and potentially combining other pension funds into this plan. The new SSAS is permitted to loan up to 50% of the assets and needs to meet various other conditions to be able to be authorised. These are:
- The loan term cannot exceed five years
- The repayments must consist of capital and interest
- The interest rate must not exceed evidencable commercial rates and must also be at least 1% above the average of the base lending rate of six major high street banks
- The loan must be secured and typically on a property owned by the business
The various conditions mean this approach may not work for all businesses. Furthermore, the restriction to 50% of net SSAS assets means it may not be possible to secure the amount of loan required.
A benefit of a SSAS however is the ability to bring various pensions into a single pooled plan. This could allow the various shareholders to each contribute to a SSAS to increase both the borrowing power and reduce the reliance on any one member’s pension fund.
This second part is important as a loan to a member’s own business represents significantly more risk with the client’s livelihood and now part of the pension fund dependent on the performance and viability of a single business.
Purchasing commercial property within a pension
If the individual through their business, owns the property in which they operate from, another option available would be the outright purchase of this property by the pension from the business. The main benefit of this option is the reduction in costs, by virtue of having no loan or debt to service (compared to the previous option).
A second big advantage is the cash injection to the business. By selling the property to a pension (or across different pensions) the business also gets this cash injection without selling the property to an unconnected party and having no ‘control’ on ability to use the property.
Once owned by a pension, the property is an asset of the plan and earns a rental income (which has to be paid at commercial rates) from the business for use of the property. There is also favourable tax treatment for the property within a pension (no capital gains on disposal of the property and no tax on rental income received).
The main disadvantages of this approach are:
- The business now has a regular expense associated with the property (rent) which was not the case before.
- The members’ pension plan is invested either solely or heavily in a single asset. This could have liquidity problems (particularly on death) and exposes the fund to the performance and return of a single asset.
Using borrowing within the pension
This can be achieved within a SIPP or within a SSAS and can be used in combination with any of the options already outlined. If it is being used with the first option (accessing the fund flexibly) the main benefit of a loan within the pension will be to create liquidity for the PCLS payment (i.e., where the majority of the fund value is within a commercial property).
The main rules on borrowing within a pension are that any loan must not exceed 50% of the pensions’ net assets. This last distinction is important where there are multiple loans in force which can well be the case if borrowing was used to buy an asset in the plan in the first place.
Any funds borrowed within a SIPP or SSAS can generally be used to:
- Fund PCLS and/or taxable income
- Fund purchase of a commercial property
- Be used to provide a loan (SSAS only)
As any loan will be commercial in nature, the availability of a loan for any given investor and the terms afforded will vary. It is also possible for loan to be on an unsecured basis though in reality, it may be difficult to source an unsecured loan in the current environment.
These represent a few of the options available to clients and their business and focus only on the pension side. We have seen some of these strategies used in the last few months and expect to see more in the coming months, particularly as it looks as if other funding options get withdrawn or are exhausted.