Tax Questions: Using your pension fund for a tax-efficient loan
If your company is short of cash,the bank interest rate you have been quoted is high and the repayment period short, needing personal guarantees, maybe you could borrow from your pension fund instead.
There are tough rules in pension and tax legislation, ones that prevent you from accessing your pension savings before you reach the age of 55. There are exceptions, but generally you can’t touch the money without getting hit with significant tax charges. But, if you happen to be 55 or older, you might be able to use your personal pension savings to raise finance and use tax efficiently.
Subject to tax anti-avoidance rules you can take a lump sum from your pension and use it for any purpose, e.g. to help out your company cash flow. Your company can repay what it owes you by paying pension contributions into a different personal pension plan. This is ‘pension recycling‘ and you need to be careful not to trigger the Money Purchase Annual Allowance (MPAA) as this would make the scheme less tax efficient.
- Bank loan example: Sion’s company needs £30,000 to buy new machinery. The bank is prepared to lend at an APR of 12% over four years, if Sion agrees to secure the loan with a mortgage on his home. The repayments would be £790 per month, that’s roughly £37,920 in total. The company can claim a tax deduction for the interest which will reduce the cost by between £1,500 and £1,900 approximately, depending on the rate of Corporation Tax (CT) applicable to its profits, making the net cost between £36,020 and £36,420.
- Pension recycling example: Sion takes a tax-free lump sum of £30,000 from his pension savings (reorganised personal pension funds to accommodate). His company needs to pay £690 per month into a new pension plan for Bob (assuming pension savings grow at 5% per annum, realistic even in times of low returns on investments) for which it can claim CT relief. The total cost to his company is between £27,471 and £29,669 depending on CT rate applicable. Sion is better off by around £7,000-£8,500 compared with taking a bank loan.
- Flexible arrangement: If Sion’s company can’t afford pension contributions but must have the cash, using Sion’s pension fund as the source of capital is the ideal solution. Sion can instead take the £30,000 tax-free lump sum, lend it to his company and leave it at that, or allow it to pay pension contributions for him as and when it can. This has the advantage of preventing or reducing the risk of the MPAA applying.
- Tax-free payments: If Sion’s company doesn’t pay pension contributions you might think Sion lost out by using the lump sum from his pension. That’s because you’re only allowed to take up to 25% of each pension fund’s value as a tax-free amount, and so what he takes from that fund in future will be taxable. The money from Sion’s pension fund counts as a credit to his director’s loan account with his company. This means when it repays the money it will be tax free. Alternatively, if it doesn’t repay Sion and he sells the company or winds it up, £30,000 of what he receives for it will be tax free. So, one way or another, he hasn’t lost his tax-free lump sum.
If you’re 55 or over you can take a tax-free lump sum and lend or give it to your company. It can repay the loan by making contributions to your pension fund on which it can claim a tax deduction. On a £30,000 loan this could save your company up to £8,500.
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