Pension loans - are they legal?

A pension loan is (and we are quoting from information already in the public domain) a scheme whereby a UK pension holder can get a loan of up to 50% of the value of their pension fund.

Sounds great in theory but they also throw up a lot of questions such as:

Are they legal? How do they work? What are the issues with this? Are the loans taxable? Do you have to pay the loan back? Where is the remainder of the pension invested? Will the remaining pension fund also become taxable as a result?

The first thing we need to state is that there does appear to be a demand for this type of product, otherwise there would be no websites catering for them and one search on the internet brings up lots of different sites all offering pension loans or pension advances. However, just because something is in demand does not make it a legitimate product or service.

The rules surrounding pension release in the UK are pretty clear...if you are 55 or over then you have the ability to release up to 25% of your pension in a lump sum. The 25% lump sum is not subject to tax and this process falls in line with guidelines set out by HMRC and a quick search on the internet brings up a plethora of ethical, legitimate companies all offering this service.

So, releasing up to 25% of your pension when you have reached 55 is ok and is line with Revenue guidelines. But what if you are below 55 or you want to release more than 25% from your pension fund?

Well, that is where pension loan schemes come into play.

We will answer the questions above as best as we can with the knowledge of the various schemes that we have. All of our information is gleaned off the various websites so we make no claims to the validity, legality, tax status or otherwise of such schemes.

Are they legal?

The simple answer is we don't know. You would have to look at the scheme details very closely but we would hazard a guess that most of the pension loans schemes out there are probably within the letter of the law, if not the spirit. However, the legality of these schemes is not the main issue at all; the major issue with them is tax as incorrectly structured pension loans can leave pension holders in an extremely vulnerable tax position.

How do they work?

Again, this information is just what we have read from looking at all of the pension loan websites out there currently but they appear to work like this.

The UK pension holder transfers their pension into a new pension product. Somehow, your pension is then invested in another vehicle which enables the pension loan provider to arrange a loan' to you of whatever amount you have agreed.

What are the issues with this?

There are a number of issues which you will need to sort out or at the very least, get comfortable with. They are:

Where is your pension invested?

You need to find out if your pension is invested in a HMRC approved pension scheme and if it is being invested onshore or offshore. You also need to take a close look at the charging structure to see what you have been charged and what you will be charged every year by the pension scheme administrators for managing your pension fund.

Is your pension loan actually a loan?

This is very important. For a loan to be a bona fide loan, it must be lent to you on commercial terms. In English this means that the loan must have a commercial interest rate attached to it so that you are paying interest on your loan every month, quarter or year, much as any other traditional loan product would have. If no interest is charged, then this is not a loan and could be subject to some huge tax penalties from HMRC.

If the people / company arranging your loan simply transfer your pension into a scheme that allows them to take' cash out of it and give to you, then this is what is known as pension liberation and the Revenue have some very strict guidelines on this.

Are the loans taxable?

Again, difficult to say although we would hazard a guess that the vast majority of pension loan schemes are simply not pension loans at all but simply another way of dressing up unsophisticated pension liberation schemes which means you would probably be hit with an unauthorised tax charge of up to 55% by HMRC.

The best way to find out the tax status of what you are looking to do is to ask your pension loan provider for a copy of their Barristers tax opinion. If they do not provide you with a copy then you are really going into that transaction blind and should steer clear.

Do the loans have to paid back?

If it is a loan then all loans have to be paid back, either from the lump sum available to you when your pension matures or by paying it back each month or year.

Where will the remainder of the pension be invested?

Ask for a copy of their investment memorandum or speak to the trustees of the firm handling the transfer of your pension. Investment in unlisted companies is fine in certain cases but make sure that you are comfortable with their investment strategy. If you are not or even have some tiny reservations, walk away.

Will the remaining pension fund also become taxable as a result?

This depends on how the pension loan has been arranged. If an adviser or company offers you an advance of their commission or a commission rebate, then the chances are that the whole of your pension fund will become taxable because advance commissions in lieu of a payment to a pension fund holder can also considered to be a case of pension liberation.

Of course, not all schemes should be tarred with the same brush however, if you are a UK pension holder and thinking of trying to get a pension loan, you need to look at each scheme on a case by case (or company by company) basis and get comfortable with the tax issues for each scheme.

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