All About Pension-Led Funding
Pension-Led Funding Case Studies
Business Owners Are Now Using Their Pensions As An Alternative Source Of Business Funding
Despite the government’s best intentions, four out of 10 small UK firms were refused banking facilities in the second quarter of 2012. A recent University of Surrey report described SME attitudes towards banks as "ranging from disappointment to contempt". As a result, small businesses are seeking alternative sources of non-traditional business funding.
Pension-Led Funding Offers A Sophisticated Alternative Involving Business Owners’ Accrued Pension Benefits To Back Their Own Organisation
This form of finance appears to be a well-kept secret. In research commissioned by Clifton Asset Management, almost half of business owners turned to their accountant for funding advice, but almost three quarters (73 per cent) were unaware that they can source finance directly through their own pension funds. A recent article on Accounting WEB also illustrated how there's a real appetite from accountants to find out more about this innovative form of finance.
When It Comes To The Alternative Funding Options Available, Here Are The Top Ten Aspects Of Pension-Led Funding
1. The Options
The two main vehicles for interaction between a pension and a business are Self-Invested Personal Pensions (SIPP) and Small Self-Administered Schemes (SSAS).
The two main funding options are:
- A commercial loan from the pension scheme to the sponsoring limited company.
- The purchase of Intellectual Property (IP) by the scheme.
2. The Rules
When considering a SSAS loan to the business, the main regulatory requirements are:
- It must not exceed 50 per cent of the pension fund’s net asset value.
- It should be secured via a first charge against an asset of equal or greater value to the loan capital, plus interest over the period of the loan.
- The maximum term is five years.
- An interest rate of at least one per cent higher than the Bank of England base rate should be applied.
- It must be repaid with equal instalments of capital and interest throughout the term.
Many directors are frustrated by knowing the quality of their business, but being unable to convince lenders whose own interests often come before the business they are funding. Traditional lenders may be quick to demand their money back if the climate dictates and will usually require personal guarantees or a charge over a personal asset such as a director’s home.
Whilst not an either/or option, pension-led funding changes the balance of control because it's funding by the directors for the directors, which adds a significant incentive to drive business success.
Most importantly, where pension-led funding replaces existing facilities, business charges and personal guarantees can also be removed. The security of a director’s non-pension personal assets will no longer rely on the fortunes of the business.
Equally, if balance sheet assets are used to secure the loan, the pension can create its own charge over all assets and the pension scheme becomes a preferential creditor to the business. In the worst case scenario of business failure, the scheme now stands first in line to call in its security, not the bank.
4. Using Intellectual Property (IP)
Arising out of the changes following the Finance Act 2004, Intellectual Property (IP) became a more recognised and permitted asset class for pension-led funding by HMRC. The most commonly recognisable IP assets are patents, trademarks, designs, copyrights, databases and domain names.
Once identified, the IP needs to be valued by an independent expert to meet HMRC requirements. The asset can then be used either as collateral for a pension loan to the company, or purchased by the pension from the business.
As well as injecting fresh capital into the business, the IP is now held within a creditor-protected pension environment. Further benefits include the fact that any appreciation in the value of IP, or income derived via lease or licence agreements, is free from direct taxation.
Pension-led funding is not appropriate for every business. If a business owner doesn’t have a large enough pension pot to make the process viable, this form of funding is a non-starter. The funding also has to benefit the owner of the pension scheme so, if a business is about to fail, then no responsible pension advisor or scheme trustee is going to agree to pension-related finance.
Developing an IP-led pension-based funding strategy requires detailed assessment of company accounts, track record and business plan, as well as answering these key questions:
- Is the organisation a limited company, a partnership, sole trader or LLP?
- What are the existing assets and liabilities?
- Is the business meeting the terms of its facilities?
- Could cash flow be improved with a restructuring of facilities?
- Who are the shareholders of the business?
- What is their personal wealth situation?
- Is there a large age gap amongst the owners/directors, with differing views on their retirement/exit plans?
6. Researching Funds
The combined value of existing pension funds is critical: generally, the larger the pot, the greater the potential for business funding.
Final salary arrangements may be considered, but significant caution is needed when examining occupational pensions. It might well be the wrong decision to leave a final salary schemes, or indeed a personal pension, particularly in cases where guaranteed annuities, spouses’ pensions, or transfer penalties may be included.
A qualified adviser should be used for all aspects of pension analysis. The adviser should have a proven track record, supported by robust corporate and compliance infrastructure, as the penalties for unauthorised transactions or incorrect due diligence can be significant.
7. Pension Benefits And Self Investment
The rules regarding drawing pension benefits from a SSAS or SIPP engaged in business funding are no different to those applied to all personal pensions. Providing sufficient cash remains within the scheme, the 25 per cent pension commencement lump sum and an income can begin or continue to be taken once the director has reached the age of 55.
It should be remembered in taking this decision, that monthly loan or lease repayments are being made to the scheme as a result of the funding, so the available cash will be re-generating.
8. Scheme Structure
SASS and SIPPS are established under trust. The trustees are typically the stakeholders in the business. Technically, the scheme can be run by the trustees themselves. But it's advisable to appoint a professional administrator specialising in pension investment to ensure governance and investment decisions are in the best interests of the members.
Pension-led funding should not be seen as a quick fix, but as part of a wider review of current and potential future arrangements. It should both strengthen the company and enhance the directors’ personal wealth in a cost-effective, tax-efficient manner, through to the eventual sale or succession of their business.
A minimum six to eight week timeframe for the whole funding process is usual. This could be longer for more complex transactions, as the proposal is likely to involve liaising with existing lenders and pension providers, IP experts, HMRC, and others.
Using an advisory firm and experienced trustee will ensure a faster development of strategy and ensure the necessary due diligence is carried out with minimal impact on company time.
10. Cost Versus Benefit
Pension-led funding is likely to be more expensive than existing pension arrangements, so ensuring value for money is critical. A significant cost will be the initial advice, which covers time and expertise of an experienced advisor.
However, when considering costs, it’s important to take into account the money saved by the company from third party arrangement fees, interest-debt and other disbursements. Under the pension-led option, the client’s own pension scheme enjoys the profits associated with such a facility.
The perfect scenario is that the business and pension grow in tandem, with one working for the benefit of the other. However, the most difficult variant to quantify is the impact self-investment funding will have on the business and ultimate retirement wealth of the owners. Ultimately, it's the directors of the business who are best placed to measure this opportunity cost.
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AJ Bell Is Often The Best Value SIPP For Stockmarket Assets
Over time, charges can wipe out a huge part of your fund. We like AJ Bell because there are no set-up costs. If you hold passive funds, which is our preference, or shares, investment trusts, EFTs, gilts or bonds, you pay one small fixed fee no matter how large your fund. And when you come to draw your benefits either as occasional drawdown or UFPLS payments, there's a small charge for the whole year no matter how many times you access your money (many SIPP and SSAS providers charge more than this for each payment). However, you should always compare charges in detail, because AJ Bell could be more expensive than other providers, depending on the type of stockmarket assets you hold.
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