Sally Hamilton says high earners can maximise the power of Sipps but there are risks and pitfalls to avoid.

Self Invested Personal Pensions continue to be fashionable in 2011 with both the number of plans started and the value of Sipp assets rising steadily despite the turbulent economic times. One key part of the Sipp market seeing growth is the company director and entrepreneur sectors as executives turn to Sipps to both release finance for their businesses and help with pension planning during times of volatile company and personal earnings.

Pensions Management magazine’s survey in May 2011 estimated that there were 600,000 plans in force, up from over 585,000 last year and that the value of underlying investments in Sipps has risen from £67.9 billion in 2010 to in excess of £90 billion this year.

While low cost Sipps continue to do well with consumers, the fully-fledged variety is attracting entrepreneurs and company directors who want to invest their pension cash efficiently while they are still running their businesses rather than having their eye purely on their retirement benefits. To achieve this aim, many are using their pension pots to raise money for their business, sometimes borrowing cash against the pension assets to buy their business premises which, if they own the building already, provides a useful degree of tax efficiency.

Dan Woodruff CFP^CM of Woodruff Financial Planning in Colchester, Essex says Sipps provide a useful pension route for entrepreneurs often sceptical of the rigidity of traditional pensions. He said: “Business users don’t generally like pensions as they tie up their money. They prefer to make use of any dormant assets. Using a Sipp to buy their premises appeals because of the rental income and any capital gain is tax free.” However, there are certain restrictions applied when putting a property in your pension and Sipp holders need to accept that a third party now owns it. Mr Woodruff said: “If you want to paint the premises pink you’ll have to get permission from the Sipp trustees.”

Changes to pensions rules over recent years have encouraged more people to think about Group Sipps to achieve the property purchase more easily. Previously a Sipp could borrow up to 75 per cent of its assets to buy a premises, whereas it is now 50 per cent. Group Sipps are still single pension plans (but with one administrator) held by individuals who are linked in some way to the same business, such as in a dental partnership or a firm of accountants, so together they can get more bang for their buck by pooling their pension cash to buy their property.

John Lawson, head of pensions policy at Standard Life, says that investing in commercial property is by far the most common reason behind setting up the smaller Group Sipps. He says the bigger Group Sipps used by big companies tend to be more like Group Personal Pensions and are used primarily to allow employees to roll over share options.

Mr Lawson said: “There is a steady stream of interest in property at the moment. It can be quite useful in the current climate for those who already own their property and want to sell it to the Sipp and inject the money into the partnership to expand the business, buy equipment or if money is tight even to pay salaries. While it does free up a bit of cash you need to realise you lose control over the asset and it is the trustees, which may or may not be the business owners, who have to make sure the rental is paid. If the rental is not kept up, the Sipp will foreclose on the partnership.’

The good news is that rental payments, which must be at the market rate, are a business cost that can also be offset against tax and the rental also tops up the pension tax-free. Mr Lawson said: “An attraction of rental income is that it is not counted as a pension contribution so it is over and above the annual £50,000 individual contributions limit.”

He added: “Another reason for putting a property in a Sipp is because prices are deflated. You might sell it at a loss to the Sipp but you may be able to make use of losses relief and any future growth in the property value in the pension is tax free.”

Andy Leggett, insight analyst at financial research group Defaqto, estimates that about 20 per cent of Sipps invest in property in some form. He said that important procedures must be followed to avoid penalties. He said: “Properties must be purchased at market value so there is no option for the pension paying an inflated price. That would be an unauthorised payment and would attract a tax charge. The rent paid must also be at market value and if they fall behind in the payment the pension fund will need to pursue them. There is no forgiveness because of the personal link.”

Chris Smeaton, head of product development at Sipp provider James Hay, says high earners and company directors tend to be attracted to the flexibility of the plans. He said: “Group Sipps have the flexibility of a sole Sipp. The only problem might be that the remaining people might not want them to keep their share of a property. In these circumstances they would have to buy the rest out.”

The bigger the group the more complex such arrangements can be.  Mr Lawson said: “We had a case where a group of 100 solicitors looked at buying their premises but it never went through. When co-buying it can be difficult to get agreements sorted. If you do go ahead you need to have clear rules of engagement even for smaller groups. A partner could leave or die so you need to cover off the implications of that.’

Chris Jones, marketing director of Sipp provider Suffolk Life, which owns 2,300 properties on behalf of 4,000 Sipp investors, agrees that investors must check with their Sipp provider the finer details of any financial as well as administrative implications relating to leavers and joiners. He said: “They need to find out whether there is likely to be stamp duty land tax charged, which could be thousands of pounds, and any legal fees or mortgage arrangement fees. In some cases the mortgage may need to be paid down and another one taken out.” With all these potential pitfalls, financial and legal advice is a must. Mr Lawson said: “It is not something to be done with a DIY approach. You need a Financial Planner’s help.”

Entrepreneurs who want to borrow money directly from their pension cannot do it with a Sipp. Loans to individuals linked to the business in any way are not permitted. Their only option is to go down the Small Self Administered Scheme (Ssas) route. These are only for limited companies and can make more financial sense for larger groups of six members or more, as they tend to be cheaper to run than six plus individual Sipp schemes.

One option for Sipp investors of a certain age but who want to continue working is to tap into the tax-free cash they are permitted to take from their pension at 55. Mr Lawson said: “They can use that capital now for whatever they please, which could be for their own personal needs but they could also put it back in to their business as a director’s loan and receive tax relief.”

Billy Mackay, marketing director of Sipp provider AJ Bell added: “What company directors also like is that they can draw down from their pension at age 55, which suits those who perhaps want to stop working as much. They can supplement the lower income they are earning from the business by drawing down the pension but still hopefully maintain a decent level of pension fund.”

Sipps can be used to make loans to third parties as an investment, although not all providers permit it (see table). This has been touted as a way to make money in the post-crunch market where many small businesses are still struggling to obtain bank finance. Mr Lawson is wary of this. He said: “Bankers are the best people to understand the lending risk. Someone who makes widgets would be daft to get into banking.”

However, those who go down this route can have the loan interest paid back tax-free into the pension. Billy Mackay of AJ Bell said: “The borrower must have no connection with the director’s business. I have to admit I haven’t seen lot of demand for lending to third parties.”

Patrick Murphy CFPCM of Bluefin Wealth Management in London, says that in his experience “the majority are using Sipps to cover a wider range of investments rather than investing in property,” although he has some longer standing clients who bought properties for their Sipps when the rules were more generous. He said: “I have one client who has a couple of commercial properties in his Sipp who is nearing retirement. The Sipp is valued at about £1.5m of which the properties are worth £1m. His position is that he is nearing retirement and wants to draw down income. Selling in the current market is not ideal so what he is going to do is drawdown using the rental income for the moment and he will look at disposing of the properties at a future date.”

Mr Murphy says the banking crisis has encouraged one client to look at converting his Sipp to a Ssas. He says: “His business suffered during 2008 when the bank pulled his funding and although his business is profitable now he doesn’t want that to happen again. It’s fairly easy to set up a new Ssas and transfer the Sipp investments in specie. People were put off Ssas in the past because they are trust-based schemes with all the reporting requirements that requires. They thought Sipps were broadly the same but many didn’t realise that loan-back wasn’t available.”

Stephen Willis CFP^CM of Piercefield Asset Management in Bristol, says good advice is required for those considering a Ssas for loans. He said: “It is a potential minefield because any unauthorised payments going into the Ssas can lead to punitive taxes. Any loan must also be repaid within five years and that can be a concern if the business falls on hard times during that period.”

Company directors considering sheltering their company shares in their Sipp need to beware of the risks. Mr Lawson said: “If they or linked family members gain a controlling interest in the company then the investment becomes taxable by as much as 70 per cent tax on the pension assets.” For this reason, Mr Lawson says most big Sipp providers do not permit a client’s company’s shares to be held in a Sipp.