Case Study – SSAS loan back
Steve and Sue have a small, successful limited company which they are looking to expand, however, like many other small companies, they are reluctant to go to a high street bank to borrow funds. Both are keen in seeking alternative sources of funding and have been told by a financial adviser that it could be possible to borrow money from their pension fund.
Both individuals are members of a Small Self Administered Scheme (SSAS) valued at £500,000 which is invested in a range of collective investments as well as a large amount of cash held within a deposit account. Steve and Sue both have a 50/50 equal split of the total value. Their limited company is the sponsoring employer for the SSAS.
After careful consideration, they requested a further meeting with their financial adviser to establish how they borrow money from the SSAS and would like to know further information to be able to action this.
What do they need to know?
HMRC legislation states that loans made to the sponsoring employer will qualify as an authorised payment as long as the following 5 key tests are met:
- Maximum amount of loan
- Interest rates
- Term of loan
- Repayment of loan
If the loan fails to meet any of these tests, then it will be deemed as unauthorised payment and will be subject to tax charges.
Maximum amount of loan
The maximum amount of a loan which can be made to a sponsoring employer is 50% of the total amount of cash held and the net market value of the assets of the SSAS immediately before the loan is made. As we know that the value of the SSAS is currently at £500,000, this would mean that Steve and Sue could lend up to £250,000 to their employer.
The knowledge of knowing they can lend £250,000 is an advantage, as this loan amount is significantly higher than what most high street banks will lend for small business loans.
The 50% limit is applied at the date the money is lent and should the value of the collective investments drop, then the amount does not need to be recalculated unless the terms of the loan changes.
To make a loan to the sponsoring employer, then it must be secured as a first charge of the asset.This asset however does not need be owned by the sponsoring employer. At the time of the loan, the security used must be of least equal value to the amount that is lent.
A common asset that is used as security is property, therefore, if their company has a business premises this could be used as long as it has an appropriate valuation and no other charges against it. Commercial property is also the most efficient form of security.
The interest rate of the loan made can be selected by the scheme members. However, the rate charged must be at a commercial rate calculated at 1% above the average base lending rate of the 6 leading high street banks. The 6 leading high street banks are;
- Bank of Scotland
The current average base lending rate is 1.75% which means that a minimum interest rate of 2.75% can be charged on the loan from the SSAS. This amount is lower than the high street banks making it more attractive to use this form of lending as an alternative. The rate of interest that can be charged can be fixed which means that should the base lending rate change, then no recalculations need to be carried out, unless the terms of the loan changes.
Term of loan
The repayment of the loan must not exceed 5 years from the commencement date. However, if the sponsoring employer experiences financial difficulties, then the outstanding balance of capital and interest can be rolled over for a further 5 years. This can only be done once and will not be treated as a new loan.
Repayment of loan
All loans made to a sponsoring employer must be repayable in equal instalments of capital and interest.
For example, if Steve and Sue decide to borrow £100,000 charged at fixed rate of 4% compounded over a 5 year period the total amount that will need to be paid would be £121,665.
The maximum amount repayable at the end of each year would be calculated as follows;
Year one [(£100,000 + £21,665)/5] x 1 = £24,333
Year two [(£100,000 + £21,665)/5] x 2 = £48,666
Year three [(£100,000 + £21,665)/5] x 3 = £72,999
Year four [(£100,000 + £21,665)/5] x 4 = £97,332
Year five [(£100,000 + £21,665)/5] x 5 = £121,665
Therefore, in accordance with the loan agreement, the repayable amount each year would be £24,333.
Should the employer default on the loan then the security held will need to be sold to provide the necessary cash to repay the loan. If the security is the property of the employer then this could cause detriment to the business.
Having a loan as an investment in a SSAS can cause liquidity issues, if for example, Steve or Sue wish to receive a tax free lump sum or income once they reach pensionable age.
By proceeding with lending from Steve and Sue’s SSAS to their employer, it will provide the necessary funding to support the expansion of their business, they could get a better interest rate than the high street bank and the employer will most likely be able to borrow a higher rate.
Any repayments made by the company will be classed as a business expense, meaning that it will reduce their corporation tax liability as well as receiving funds in their SSAS to provide an increased value ready for their retirement.