Why would a pension scheme borrow?

As experts in transactions involving commercial property, we handle lots of questions about pension scheme borrowing. Sometimes these loans are to assist with the purchase of a property, but could be for other reasons, and occasionally does not involve any property at all.

In this article we explore the limits and cover some additional reasons why a customer may find the facility useful.

Firstly, what is borrowing?

This may seem obvious, but it is a transaction where an external party makes a loan to the pension scheme.

The loan is subject to a written loan agreement setting out the terms, including the period of the loan, the interest rates and repayment schedule.

The loan could be secured (usually by a legal charge over an asset or assets of the pension scheme) or unsecured.

Note that a debt owed to the pension scheme will not usually be classed as borrowing.

Who can lend money to the pension scheme?

We allow commercial lenders and other parties to make a loan to our pension schemes. We do not facilitate the introduction of the borrower and lender; this is something customers must arrange themselves.

A lender could be a normal High Street lender (i.e. a Bank) or it could be any company or individual willing to lend to the pension scheme. A customer may even lend to their own pension scheme!

If the lender is not a conventional source, we would undertake Anti Money Laundering checks to make sure we were comfortable with the choice of lender. We don’t allow anyone outside of the UK to act as the lender.

Connected party loans

If the lender is a connected party, such as the customer, a relative, or their business, any loan needs to be on commercial terms. The loan can be on a secured or unsecured basis, but this will likely affect the interest rate charged.

For connected party loans, InvestAcc can prepare an unsecured loan agreement. Sometimes these loans can greatly reduce the time it takes to complete the transaction, compared to typical bank borrowing.

Purpose of the loan

Although borrowing is typically associated with a new commercial property purchase, it can also be for other purposes such as the remortgage of an existing commercial property.

There can be other times when the pension scheme may look to borrow, even if it does not own any property. An example could be that someone wishes to take benefits from the pension scheme but have a particular investment which is illiquid or one which they would prefer not to be sold at this time.

What is a VAT loan?

If a pension scheme is buying a commercial property and the vendor is charging VAT on top of the purchase price, it may be possible for the pension scheme to become VAT registered and make an option to tax the property, so that this VAT can be recovered usually a few weeks later.

However, this can increase the amount of cash required to complete the purchase and, in some cases, there may be insufficient money available. This shortfall can be funded by a loan to pay the VAT, but bear in mind that this is treated like any other borrowing and must be within the overall borrowing limit, including any other loans.

This can also be useful where a customer has the available funds but prefers not to make additional contributions to the plan (e.g. because they have already used their available annual contribution allowances).

Maximum loan

The maximum loan is up to 50% of the net asset value of the pension scheme on draw down of the loan. The net asset value is the value of all the assets minus any liabilities (e.g. outstanding loans).

It will be necessary to establish the value of the assets of the scheme, otherwise unauthorised payment tax charges may occur if the scheme borrows in excess of this amount. If the pension scheme already owns commercial property, it may be necessary to obtain up to date values, depending on when this was last done.

In broad terms, a pension scheme with net assets of £100,000 can borrow up to £50,000.

If the pension scheme already has borrowing, this amount would reduce, or eliminate, the amount of new borrowing. For instance, if the pension scheme had net assets of £100,000 and an existing loan of £30,000 then the maximum new loan is only £20,000.

Affordability

Lenders will make their own decision based on the financial position of the pension scheme, including lease terms and the financial position of the tenant.

We would expect that rental income exceeds the loan repayments by at least 30% and, at the time the loan is drawn down, the pension scheme must have sufficient cash to cover loan repayments due within the first three months.

Single or joint loans

The majority of commercial property transactions involve groups of two or more individuals jointly acquiring a property or land. For SIPPs (which are individual arrangements) we allow loans to be done on an individual or joint basis, with other SIPP members. If it is a joint loan, there would need to be a division of liability, so that one pension scheme member’s fund cannot be used to settle the debts of another.

Limitation of liability

It is standard industry practice to insert limitation of liability clauses into documents relating to the property, which a lender would usually accept. These clauses protect the pension scheme assets from the actions of others.

Want to know more?

If you are considering an investment in commercial property and land and would like to discuss whether this is likely to be possible, please get in touch with our Property Team on 01228 538 988 or email [email protected]

February 21st, 2023