SSASs and SIPPs: a technical guide

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1 R SSASs and SIPPs: a technical guide Adviser Use Only April 2011 This guide looks at some of the questions asked about SSASs and SIPPs, particularly around the investment options and restrictions surrounding such schemes. What are SSASs and SIPPs? Small Self-administered Schemes (SSAS) and Self Invested Personal Pensions (SIPP) are particular types of pension scheme that allow greater investment flexibility than other pension schemes. They allow the member to direct their investment into certain assets hence they are also known as member directed pension schemes ; HM Revenue & Customs (HMRC) regard them as investment regulated pension schemes. SSASs are small occupational schemes where members are trustees and can influence and make investment decisions and SIPPs are personal pensions with greater investment options. These schemes are subject to the same tax regime as any other registered pension scheme so the rules on contributions and benefits for example are the same; however there are some differences between these two types of scheme which this guide will outline and at the end you ll find a table that summarises the differences. Small Self-administered Schemes So tell me more about SSASs? SSASs first took off as the pension scheme of choice for controlling directors in the 70s and 80s. Initially there were no investment restrictions and most of the regulation was carried out on a discretionary basis. In 1991 the Retirement Benefits Schemes (Restriction on Discretion to Approve) (Small Selfadministered Schemes) Regulations were released which defined a SSAS as a retirement benefits scheme where: some or all of the assets are invested other than in insurance policies; at least one scheme member is connected with another scheme member, trustee or the employer; and where there are fewer than 12 active members. SSASs became popular with controlling directors (often family businesses) because they found they could use their pension scheme to help their business, most commonly by using their SSAS to purchase a property which was then rented to the company. Nowadays it s probably more usual for SIPPs to be set up as they offer similar investment opportunities but greater flexibility and portability as well as less administration, though SSASs can offer some advantages. How are SSASs set up? SSASs are set up under trust and typically all members of the SSAS will be trustees. Prior to April 2006 there was a requirement for a SSAS to appoint a Pensioneer Trustee. This was an independent individual or a company recognised as a professional in their field. Their primary role was to ensure the SSAS was not wound-up outside of the rules (trust-busting). Later there was a requirement for the Pensioneer Trustee to be co-owner of all assets and co-signatory on the scheme bank account. Since 6 April 2006 this requirement no longer exists however many SSASs retain a professional trustee to assist with the administration and regulation of the scheme. What duties do the trustees of a SSAS have? SSASs are regulated by the Pensions Regulator though are exempt from some requirements due to there being less than 12 members. The Pensions Regulator keeps a register of pension schemes so trustees must provide any required information and ensure changes are reported. Scheme returns may be required (though one member schemes are exempt) as well as annual accounts. In many cases the trustees will be the scheme administrator from an HMRC perspective so will need to comply with other requirements such as the payment of benefits, provision of information to members, completing the scheme return and Event Report and dealing with tax charges where required. While it s true that there are more administrative and regulatory responsibilities with a SSAS, it is also true that many providers will include such services in their offering.

2 How are SSASs structured? The fund in the SSAS is pooled so all contributions/transfers are put together and used to make any investments and used to pay any benefits. The assets held within the SSAS are not earmarked for individual members so a member cannot identify their share or get an immediate valuation in most cases. It is the trustees responsibility to work out how much is paid to a member at retirement or to their beneficiaries on their death. Most scheme documentation determines how a member s share is determined such as the contributions made by and on behalf of the member plus growth and less charges/expenses. Reallocation of a member s share of the fund can give rise to an unauthorised payment. In some cases though it may be possible for trustees to apportion the growth in a different manner though there are some conflicting views on this. Who would join a SSAS? Fewer SSASs are being set up these days mainly in favour of SIPPs. But while it seems to be becoming a niche product it still offers some advantages particularly for controlling directors of private companies. SSAS may give the members more control as they can choose the investments; they can also change their administrator relatively easy. Having a pooled fund can help where a member transfers or retires as trustees would have flexibility in where to pay benefits from (assuming fund is large enough) so that particular assets don t need to be sold. SSAS are often accused of being more expensive than SIPPs; this may be true where one-member is concerned but when compared to a group SIPP the costs can be comparable; much depends on the provider. How does a SSAS provide benefits? A pension commencement lump sum can be paid and where the SSAS was in existence on 5 April 2006 there could be an entitlement to more than 25% calculated in line with previous Inland Revenue maximum benefit calculations which were based on final remuneration and length of service. Self Invested Personal Pensions What is a SIPP? A SIPP is a personal pension where the member can choose from a wide range of insured and non-insured investments. The idea of SIPPs was first voiced in the 1989 Budget and then confirmed in the Inland Revenue s Memorandum 101 which set out the permitted investments for self investment. Since then the market has grown and SIPPs have been one of the biggest pension success stories of the last decade; there is estimated to be 75 billion in such arrangements. This success however did not go unnoticed by the Financial Services Authority (FSA) who carried out a thematic review on pension transfers in 2008 and have since carried out a review of small SIPP providers. SIPPs have been regulated by the FSA since How are SIPPs set up? SIPPs can be set up in the same ways as other personal pensions: under a trust or by deed poll. Trust-based SIPPs, with the provider acting as trustee, are more usual and often preferred. Insurance-based SIPPs create a private managed fund in which the assets are held in the insurer s name. Investments have to comply with the FSA s permitted linking rules so there is usually a more restricted range of investments. However insurance-based SIPPs have always allowed self-investment of Protected Rights monies, which was not made possible for trust-based schemes until 1 October The Financial Services Compensation Scheme treats trust-based and insurance-based SIPPs differently. If the trustees are unable to meet their obligations members should be able to claim from the FSCS with a maximum benefit of 50,000 (since 1 January 2010). If the provider of an underlying investment fails then the compensation depends on the type of business. If an insurancebased SIPP provider fails then claims of up to 90% can be made; the assets held are owned by the provider though rather than in a trust so could be used for payment of creditors. When it comes to pension income SSASs are very flexible and all options are usually open to the trustees. Typically income will be paid from the fund as income drawdown or a scheme pension. Scheme pensions can provide higher levels of income than income drawdown particularly from age 75. This is because the amount paid will be based on actuarial calculations based on the member s health/life expectancy. Paying income from the fund means that assets don t need to be sold. 2

3 What types of SIPP are there? Many SIPPs are offered by insurance companies as part of their complete product offering but others are offered by more specialist companies. The industry often talks about three types of SIPP: Deferred SIPP this is really a regular personal pension but with the option to self-invest into non insured assets at a later date. Hybrid SIPP such as those offered by insurance companies where there is a requirement to invest a proportion of the investments in insured funds. Full SIPP at the more specialist end of the SIPP market there are schemes that offer the fullest range of investments without any conditions. Group SIPPs (which could fall into any of the above categories) are also becoming more popular and operate as group personal pensions with the added investment flexibility of SIPPs. A group SIPP can often be used as a way for a property to be bought amongst a group of people, where for example individual fund values and borrowing would not support a purchase (however a SIPP doesn t have to be set up as a Group SIPP to allow joint purchase). They may be set-up by employers or by family groups. Who could take out a SIPP? More or less any individual could start a SIPP. The eligibility rules are the same as for all registered pension schemes: individuals who are resident in the UK and under the age of 75 are entitled to tax relief on contributions they make to a SIPP (and they can continue for up to five years if they become nonresident). Transfers from other UK registered pension schemes or recognised overseas pension schemes can also be paid into a SIPP, and most SIPPs will be started in this way as they often require a lump sum initial investment. Who would take out a SIPP? The suitability of SIPPs is a different question. Providers often impose a relatively high minimum investment; and charges can be higher than on regular personal pensions so they tend to be aimed at more financially aware clients with larger fund values. SIPPs have been the big pension success story of the last decade. The large growth in transfers, especially since 6 April 2006 however led to the FSA asking questions and in 2008 undertaking a thematic review. The FSA were particularly concerned about consumers being switched into higher charging contracts which included features or flexibility that they did not need. This accusation appears to be aimed at SIPPs as with the vast fund choices offered on some personal pensions, and the claims that as much as 30% of SIPP assets are in cash, personal pensions could be more suitable. This is generalising though as some SIPPs are reasonably priced and where deferred SIPPs are concerned these may be charged as a personal pension with the SIPP charges only applying once other assets are accessed. How do SIPPs provide benefits? SIPPs historically offered an individual a way to defer the purchase of an annuity through income drawdown (insured personal pensions can offer this as well), allowing the individual to draw an income from their pension fund while it remains invested. Drawdown hands control to the member so they can for example, take their pension commencement lump sum without drawing an income, and can take income as it is needed (within limits). Since 6 April 2011 there have been two forms of drawdown: capped drawdown and flexible drawdown. Capped drawdown is subject to a maximum income level similar to a single life level annuity based on tables provided by the Government Actuary s Department (GAD). The GAD limit must be reviewd at least every three years before 75 and every year thereafter. Flexible drawdown has no limits. A few providers are now offering scheme pensions from a SIPP. 3

4 Investments Which investments can be held by a SSAS or SIPP? All schemes are subject to the same investment rules. HMRC does not prescribe which investments are permitted so scheme trustees and providers will be responsible for determining the allowable investments under their particular scheme. Where HMRC wants to discourage investment in certain assets they levy tax charges so as to make that investment unattractive; and in turn most schemes then decide not to allow. What investments are usually allowed? Typical investment options under a SSAS or SIPP would include: Listed/unlisted shares Futures and options Units in an authorised unit trust scheme Shares in an open-ended investment company (OEICs) Hedge funds Insurance company funds trustee investment plans and offshore bonds etc Traded endowment policies Deposits - in any currency Investment trusts Freehold/leasehold commercial property or land Under a SSAS where all members are trustees, the decision on investment options should be made unanimously. Under a SIPP the investments offered will depend on the provider of that SIPP. Some are happy to accept any investment but others will be more restrictive. Sometimes this can be part of their marketing strategy with a company having perhaps a simple SIPP with investments in funds and shares for those that want some investment flexibility or control over their investments and a full SIPP for those that need more specialist investments. Are there any investments which are not allowed? Rather than not being allowed, there are certain investments that carry tax charges which make them extremely unattractive. Such investments come under the heading of taxable property. Taxable property includes residential property and most tangible moveable assets (things you can touch and move) such as classic cars, yachts, antiques, art, jewellery and wine. Note that these investments are regarded as taxable property whether they are held directly or indirectly unless held through a genuinely diverse commercial vehicle (see glossary). What are the tax consequences if taxable property is held? The holding of taxable property will be an unauthorised payment so the member and the scheme will be subject to tax charges. The member will have to pay an unauthorised payments charge of 40% and potentially a surcharge if the investment represents more than 25% of their rights. The scheme administrator will be subject to a scheme sanction charge of 40% on income from the assets (deemed income of 10% of the property value is used where actual income is less than this), as well as capital gains on disposal. 4

5 Investments in property/land: What are the advantages of using a SSAS or SIPP to purchase land or property? There are a number of tax advantages where a SSAS or SIPP is used to purchase a commercial property or land. These include: Contributions into the scheme receive tax relief. The rent received by the pension scheme is not subject to income tax. If the property is sold there is no Capital Gains Tax liability. In most circumstances there will be no liability to Inheritance Tax on death. What are the disadvantages of using a SSAS or SIPP to purchase land or property? There are some general points worthy of consideration when thinking about a property purchase: Due to the cost of most property/land this could make up a large proportion of the scheme investments so the scheme may not be appropriately diversified. Property is considered illiquid as cannot always be immediately sold, or sold for the right price. The trustees should consider that there may be a need to sell quickly if no other assets are available (for example a member could request a transfer). In order to generate good returns a regular rental income is needed and there is therefore reliance on having a tenant. Property purchases are complex and can be costly both initially and throughout the investment (maintenance charges). If rented back to the employer the scheme becomes tied to the employer consideration has to be given to what happens if the employer has financial difficulty, or indeed members of the SSAS want to transfer or even wind-up the SSAS. What type of property/land can a SSAS or SIPP purchase? Generally speaking pension schemes will only purchase commercial property; residential property is regarded as taxable property and for that reason will be avoided. The property can be located in the UK or overseas, though some schemes prefer to restrict to the UK. Commercial property includes offices, factories, hotels, care homes, shops, prisons and student accommodation (subject to conditions). What type of property cannot be held by a SSAS or SIPP? Most schemes do not permit pension schemes to hold residential property as this is classed as taxable property and leads to considerable tax charges (unless held through a genuinely diverse commercial vehicle). Direct investment in taxable property is unlikely to be a prudent investment as it would lead to additional administration and tax charges and potentially put the scheme registration at risk. There are some exceptions such as a caretaker s flat or flat above a shop (the person occupying the property cannot be a member of the scheme or connected with a member of the scheme). A property or land that is being converted to residential use or having a residential property being built on it as long as the asset is disposed of before it becomes habitable. How can a SSAS or SIPP purchase property? A SSAS or SIPP is able to purchase a suitable property from a third party, an employer or a member of the scheme. Where purchased from a connected party (employer or the member for example) an independent valuation must be carried out to ensure the transaction is carried out at arm s length and the pension scheme does not lose-out. Once a property is owned by the pension scheme it can be rented out to the employer but again this needs to be on an arm s length basis so requires an independent valuation and a lease on commercial terms. The scheme may have sufficient assets to purchase the property outright but if not can borrow additional monies to meet the purchase price. 5

6 Borrowing: Can a SSAS or SIPP borrow money? It is possible to borrow money in line with the pension schemes aims; typically this will be done for reasons of property purchase. The money can be borrowed from any financial institution, company or individual but if from a connected party it has to be arranged on commercial terms. The main restriction on borrowing is the amount that can be borrowed; which is a maximum of 50% of the current value of the scheme. A different limit for borrowing applied before 6 April 2006; borrowing already in place is permitted to continue. However if further amounts are borrowed by the scheme both the old borrowing and the new borrowing must be within the 50% limit. Loans: Can a SSAS or SIPP loan money? HMRC allow schemes to provide a loan as long as it is prudent, secure and on a commercial basis. There is a difference between SIPPs and SSASs with regard to loans and this relates to there being a sponsoring employer that a SSAS has and a SIPP does not. A SSAS can make a loan to the sponsoring employer or an unconnected third party but where a SSAS does make a loan to the employer there are a number of conditions (see below). Things can be more complicated for SIPPs; there is no sponsoring employer so they should only make loans to unconnected third parties. However when making a loan they need to ensure that the loan is not used to invest in taxable property. In light of the complications around SIPP loans many SIPP providers have decided not to allow loans at all. What are the conditions for a loan to the sponsoring employer? When a SSAS makes a loan to the sponsoring employer the following conditions apply: it cannot exceed 50% of the market value of the scheme; the term cannot exceed five years (on one occasion only the loan can be rolled over for another term if the employer is in financial difficulty for example); Shares: Are there any rules for investments in shares? A SIPP or SSAS is permitted to invest in shares and there is no requirement for those shares to be listed on a recognised stock exchange. There is a limit however where a SSAS is purchasing shares in the sponsoring employer. A SSAS can invest up to 5% of the fund value in shares of one sponsoring employer (there is no restriction on the amount of shares though so potentially 100% of the shares could be owned by the scheme as long as that was only 5% of its overall assets). If there are associated employers then up to 20% can be invested in their shares overall. SIPPs are not subject to this 5% limit because there is no sponsoring employer but if they invest in shares of a company that is controlled by the SIPP member or a connected person they would be investing in taxable property with its tax consequences. In practice this means that many SIPP providers do not allow unlisted shares. As with other investments the rules were different before 6 April 2006 and shares purchased then can continue to be held until the scheme purchases further shares when the 5% limit will apply. it must be secured as a first charge on an asset which is worth at least the same as the value of the loan plus the interest due over the term of the loan; it must be repaid in equal instalments of capital and interest in each year of the loan;. the interest rate charged must be at least the average of the base lending rates of six specified high street banks plus 1% (rounded up to the nearest 0.25%). 6 The rules on loans were different before 6 April 2006; these loans can continue. However if the terms of the loan are altered the loan will become subject to the new rules.

7 Quick comparison - SSAS v SIPP Whilst SSASs and SIPPs are subject to the same tax regime there are still a number of differences between them. The following table is a quick comparison outlining some of the key differences: SSAS SIPP Structure: Set up under trust. Pool funded (nonearmarked). Set up under master trust or by deed poll. Set-up: Usually set up by sponsoring employer, commonly through a product provider who can assist with the administration and regulation. Usually set up by individual through an adviser. Mainly offered by specialist SIPP providers and insurers. Regulated by: Pensions Regulator. FSA. Members: Up to 12 members. Will usually be controlling directors of private company but fewer restrictions since 6 April Each SIPP has one member. Group SIPPs can be offered by employers and set-up by families. Investment decisions: Determined by members who are trustees. Range of investments is determined by SIPP provider. Member can make decisions within the range. Loans: Yes, up to 50% of the assets of the scheme to an employer. No limit for unconnected third parties. Only to unconnected third parties (ensure not investing in taxable property). Borrowing: Up to 50% of the fund. Up to 50% of the fund. Self-investment: Up to 5% of fund can be used to purchase shares in single sponsoring employer. No sponsoring employer though many providers do not permit unlisted shares taxable property issues. PCLS: May have protected PCLS. Usually limited to 25%. Income options: Scheme pension/drawndown pension. Trustees can purchase an annuity. Drawdown pension/lifetime annuity. Some providers offering scheme pensions. 7

8 Glossary A Assets - These are everything that the trustees/administrators hold for the pension scheme. The four main asset classes are equities, property, fixed interest (gilts) and cash. Associated in connection with an investment an associated person is any member of the pension scheme, any person connected with a member, any arrangement relating to a member of the pension scheme or to a person connected to a member, or any associated pension scheme. C Capped drawdown pension - where the pension fund remains invested and income is drawn from it within GAD limits. A drawdown pension is an alternative to a lifetime annuity, providing flexible income and death benefits. Connected party transactions with connected parties must be carried out at arm s length. Connected transactions include transactions between the pension and the member or sponsoring employer, transactions between the pension and people connected with members/connected employers, and transactions between the pension and a third party, which is directly or indirectly for the benefit of a member or sponsoring employer. Corporate bonds a type of asset. Similar to a gilt but is issued by a company rather than the Government. They usually pay a fixed rate of interest. D Discretionary fund management (DFM) a member of a SIPP may pass the investment decisions over to a DFM who will take account of the member s objectives and attitude to risk but will be given to make investment decision on a day to day basis on behalf of the member. F Fund supermarket an online service shop where investors can buy and sell investments such as including funds, unit trusts and OEICs. Futures a form of derivative where a transaction will take place on a date in the future at a fixed price. They are high risk. G GAD - Government Actuary s Department GAD Limits - The income that can be paid from a capped drawdown pension is determined by reference to tables produced by the Government Actuary s Department. Genuinely diverse commercial vehicle - could be a unit trust, OEIC or investment trust for example that meets certain conditions. A common example which allows schemes to invest in residential property is a UK Real Estate Investment Trust (REIT). In order to be diverse, a vehicle that invests in residential property must have a value of at least 1 million and have a minimum of three residential properties with each one making up no more than 40% of the overall value. Gilts - This is a type of fixed interest security (bond) issued by the Government. Investors effectively buy a gilt with a predetermined rate of return (i.e. 6%) or an inflation linked return. The stated rate will be paid out until a set date in the future when the gilt is redeemed. H Hedge funds - an investment fund where the managers are allowed to use riskier trading techniques to try to gain a higher return on investment. Very high risk but potential for high reward. 8

9 I Illiquid assets that are difficult or slow to sell such as property or unlisted shares. Insured scheme a pension scheme where all assets are invested in insurance policies/funds. In specie - This is a way of moving existing assets into, out of, or between a SSAS or SIPP without selling the assets. Investment trust - A collective investment fund which is a listed company holding a portfolio of shares on behalf of its shareholders. O Open-ended investment company (OEIC) a company that issue shares on the Stock Exchange. Money raised from shareholders is used to invest in other companies; OEICs can issue more shares as required as they are open-ended. Options a derivative similar to futures but with an option the transaction may not happen it is optional rather than definitive. S Shares a small share in a company giving rights to dividends from the company. Shares can be listed on a recognised stock exchange or unlisted. Shares are generally regarded as higher risk than pooled investments because there is only a dividend when the company has met other commitments and unlike pooled investments you are reliant on one company s performance. T Traded endowment policies - endowment policies which have been sold/assigned by their original owner. Trust - Under a trust, named persons (called trustees) hold property for the benefit of other people (called beneficiaries). An occupational pension scheme will be set up under a trust; personal pension schemes may be set up under a master trust or in other ways. U Unauthorised payment Any payment that is not authorised under the simplified tax regime for pensions. The recipient will have to pay tax at 40% and there may be a surcharge of 15% where the amount of the payment exceeds a stated level plus a scheme sanction charge of 15%. Unlisted shares - shares that do not have a price quoted on a recognised stock exchange. They are usually very high risk and illiquid. Many providers do not allow such investments. MetLife Europe Limited (trading as MetLife) is authorised by the Central Bank of Ireland and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request. Registered address: Riverside One, Sir John Rogerson s Quay, Dublin 2, Ireland. Registration number UK branch address: One Canada Square, Canary Wharf, London E14 5AA. Branch registration number BR Web Site: M FEB PNTS 1086/1/0312G 9