With interest rates soaring, borrowing from traditional lenders is getting expensive. If your business needs extra funds, could your pension fund provide a more tax-efficient, if not cheaper, option?
Off limits
As a rule, your pension fund is off limits until the scheme or government rules allow you to access it. Even then it isn’t allowed to give or lend money direct to your company. Loans are possible with some types of occupational pension scheme but not in any circumstances from your personal pension. However, indirect arrangements are OK.
Accessing and reinvesting
If you’re 55 (or younger if your scheme allows) you’re entitled to take a lump sum from your pension savings. Once in your hands it’s entirely up to you what you do with it, which means you can give or lend it to your company if you want. To repay you in a tax-efficient way it can pay into your pension fund rather than you direct.
Trap. Taking money from your pension and reinvesting it (even via your company) is called “pension recycling”. HMRC places limits on how much you can recycle and there are tough penalties for breaking these. But, provided you stay within the rules recycling can be worthwhile.
Example. Terry’s company, Acom Ltd, requires £20,000 for repairs to its premises. As it’s a newish small company the bank will lend the money but at a stiff APR of 12%. The repayments would be £391 per month, that’s £28,152 in total. Acom can claim a tax deduction for the interest element, which will reduce the cost by £1,549, making the net repayments £26,603.
Instead, to pay for the repairs Terry could draw a tax-free lump sum of £20,000 from his pension fund. To ensure his pension fund is worth no less as a result, Acom must pay £321 per month into Terry’s fund. The total cost to Acom is £23,112 (£18,720 after 19% corporation tax relief). That’s a saving of almost £3,500 over a bank loan. It also produces some extra tax saving for Terry and is more flexible.
Tip. If Acom can’t afford to pay the pension contributions (or make the loan repayments), but must have the new equipment, using Terry’s pension fund as the source of capital can still work. He could take the £20,000 pension tax-free lump sum and lend it to Acom and allow it to pay pension contributions into his fund as and when it can.
No loss of tax-free cash
If Acom doesn’t recompense Terry by paying into his pension it might seem that it rather than Terry has benefited from his tax-free lump sum entitlement, but actually that’s not the case.
Tax and NI savings
The money from Terry’s pension fund can be credited to his director’s loan account. This means that if and when it repays him there’s no tax or NI for Terry to pay. Or, if Acom doesn’t repay Terry and he eventually sells the company or winds it up instead, £20,000 of whatever he receives out of the arrangement won’t be taxable. Therefore, Terry won’t lose his tax-free lump sum, only delay the personal advantage from it.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.