RAC, SIPP & SSAS pensions

Money purchase schemes

Personal pension and group personal pension schemes are the most common type of money purchase scheme – but they’re not the only ones. This article looks at retirement annuity contracts (RACs), self-invested personal pension schemes (SIPPs) and small self-administered schemes (SSASs).

What is a Retirement annuity contract?

Retirement annuity contracts (RACs) existed before 1 July 1988 and are sometimes referred to as retirement annuity plans (RAPs), Section 22 contracts or Section 226 contracts.

RACs were available to individuals who were in employment if there was no occupational scheme. They were also available to the self-employed.

Contributions limits were based on an age-related percentage of earnings that were assessable to UK tax. Employee contributions were paid gross and received tax relief, which was granted under section 22 of the Finance Act 1959 and then section 226 of the Income Tax Act 1970. Hence why RACs are sometimes known as section 22 or 226 policies. Employer contributions were not allowed.

On 1 July 1988, personal pensions were introduced. Contributions to existing RACs are allowed to continue (and can be increased, if allowed by the scheme) but no new RACs could be started.

How is RAC pension income taxed?

Before 5 April 2007 the taxation of pension income from RACs was different from personal pensions. Basic rate tax was taken off before the annuities were paid, unless a form had been completed to indicate the recipient was not a tax payer. Since 6 April 2007, RACs are taxed through the PAYE system in the same way as other pension incomes.

Since A-Day (6 April 2006) RACs have been able to operate relief at source, but most still operate on a gross contribution basis and don’t allow employer contributions. If contributions are paid gross then tax relief has to be claimed via self-assessment. This should be checked as some RAC policyholders forget to make the claim if they do not normally self-assess on an annual basis.

Beware tax relief restrictions too. Making a ‘Claim’, usually by self-assessment, works by reducing the client’s income subject to tax and so reducing the tax bill. Clearly if there is no tax due then there is no tax relief available.

For a member with £20,000 salary, their pension contribution is deducted before they pay tax. A contribution of the amount between their personal allowance and their taxable earnings will reduce their tax bill. They could choose to pay a larger pension contribution, however, as there is no tax due on earnings up to the personal allowance, there is no further tax relief to claim.

Tax-free cash

RACs were allowed to pay a tax-free lump sum of three times the value of the initial annual annuity, which could be more than 25% of the fund value. However, since 6 April 2006 individuals with RACs are only entitled to 25% of the fund value (subject to available lifetime allowance up to 5 April 2024 and on or after 6 April 2024 subject to having sufficient Lump Sum Allowance and Lump Sum and Death Benefit Allowance). There was no transitional protection for amounts of tax-free cash in excess of 25%.

Retirement age

Before 6 April 2006 individuals who had a RAC could not take benefits until they reached age 60, unless there were ill-health considerations or they had a special occupation. After 6 April 2006 it was possible to take benefits from age 50, until the normal minimum pension age changed to 55 in April 2010.

Death benefits

Before 6 April 1980 RACs couldn’t be written under trust, which meant any death benefits had to be paid to the estate and were liable to inheritance tax. However, after that date the death benefits could be written in trust to avoid being paid to the estate.

You can find out more in our  Inheritance Tax and Pensions article.

Self-invested personal pension schemes

A self-invested personal pension scheme (SIPP) is a type of money purchase personal pension scheme – in essence a pension wrapper in which pension investments are held. SIPPs have much wider investment options than normal personal pensions.

History

SIPPs were first introduced in the 1989 budget. The Joint Office Memorandum (101) followed later that year. This established which investments were permitted investments. Further regulation followed, and at A-Day on 6 April 2006 SIPPs became registered pension schemes.

From 2007 SIPPs had to be regulated by the Financial Services Authority, now the Financial Conduct Authority.

How is a self-invested personal pension structured?

SIPPs are often set up by the provider under trust. The provider will normally be the scheme administrator and trustee. The individuals then become members of the scheme. Investments are normally in the name of the provider or the trustee, but are earmarked for the individual member. In some cases, the member can also be a trustee.

What investments are allowed in SIPP?

The main advantage of a SIPP over a traditional personal pension is the level of investment flexibility the member has. The range of available investments is much wider than a standard personal pension. Allowable investments may include:

• UK and overseas stocks and shares
  
  
• Unlisted Shares
  
  
• Unit Trusts
  
  
• Investment Trusts
  
  
• Open ended investment companies (OEICs)
  
  
• Insurance company funds
  
  
• Deposit accounts
  
  
• Gilts and overseas securities
  
  
• Investment grade gold bullion
  
  
• Commercial properties
  
  
• Cash.
   

It is possible for SIPPs to invest in certain other investments, such as:

• residential property
  
  
• 'Pride in possession' assets such as paintings, antiques, vintage cars, fine wine.
  
  
• Non-investment grade gold bullion.
   

However, these investments are classed as unauthorised payments and are subject to the associated tax penalties.

                             Finance Act 2004 Sch 29A Pt2 and Finance Act 2005 Sch 174A

A SIPP can borrow up to 50% of the scheme's net assets (ie before the borrowing has taken place and excluding existing borrowing) for investment purposes, as long as the scheme administrator and / or trustees are satisfied that the borrowing will benefit the scheme. In practice this would normally only be used for commercial property transactions.

As an example, if we take a member with a SIPP which has assets of £400,000 and existing borrowing of £50,000. To work out the maximum that can be borrowed you take the loan from the value of the SIPP, £400,000 less £50,000. So the net value of the SIPP is £350,000. The maximum borrowing in this instance is £175,000. This doesn’t mean that a further £175,000 can be borrowed though as there is an existing loan of £50,000. So the maximum extra borrowing that can be done in this position is £125,000.

SIPPs are not allowed to make loans to any connected parties. However, they can invest up to 100% of the fund value in shares. Theoretically this could include any company controlled by a member. However, there are complications, if unauthorised payment charges are to be avoided.

1. Connected party transaction – everything would need to be at arm’s length (for example require professional valuations).

2. Value shifting – the SIPP member cannot benefit personally in any way.

3. Taxable property – the company could not own any residential property or tangible moveable property (such as a company car).

If the member falls foul of any of the above, then the investment would be an unauthorised payment.

A SIPP could invest 100% of the fund in company shares which did not have a member in control – as long as the scheme administrator agreed. One of the main investment considerations is the liquidity of the investments so that benefits may be provided as and when required. This is particularly important if there are jointly held assets with people retiring or taking benefits at different times.

Further guidance on investment principles can be found in section  PTM121000 of HMRCs Pension Tax Manual.

Payment of benefits

The SIPP scheme rules should be clear on the types of benefits it will pay to members, as death benefits, or to settle Court Orders e.g. Pension Sharing. As some SIPP investments may be illiquid, the scheme rules may allow ‘in-specie’ settlements. This is where an asset (either in full or partially) can be passed to the beneficiary in settlement of benefits due, rather than having to sell it to pass on an actual monetary amount.

Small self-administered scheme

SSASs are usually a type of money purchase scheme, but unlike SIPPs these are occupational schemes. They are normally used for small family businesses, due to the requirement for one or more parties to be connected. There can only be one SSAS per company.

Background

Controlling directors were allowed to join occupational schemes after The Finance Act 1973 allowed this and the small self-administered scheme was born. The concept of a pensioner trustee was also created at this time by the Pension Schemes Office (PSO). This was followed by the issuing of Joint Office Memorandum 58 which provided the main guidance for SSASs until The Retirement Benefits Schemes (Restriction on Discretion to Approve) (Small Self-administered Schemes) Regulations 1991 (SI 1991/1614). As occupational schemes, SSASs are also subject to the Pensions Act 1995 and the Pensions Act 2004.

A SSAS can be exempt from some of the provisions of the Pensions Act 1995 and the Pensions Act 2004 if it fulfils certain criteria. To be exempt from the trustee’s knowledge and understanding duties and member nominated trustee duties, the SSAS must:

• have less than 12 members (where there’s at least one member who is connected to another member or with the trustee or employer in relation to the scheme) and
  
  
• make all decisions unanimously, unless there’s a professional trustee.

To be exempt from the Internal Disputes Resolution Procedure, every member must be a trustee.

The tax rules for a SSAS are broadly similar to SIPP and governed by the Finance Act 2004. As SSASs are occupational pension schemes, any contributions made by the employer are classed as an expense of the business and deductible from corporation tax (subject to the wholly and exclusively provisions).

How is a small self-administered scheme structured?

A SSAS will normally be set up under trust by the employer. Each scheme member will usually be a trustee. There will normally be a corporate trustee as well. The investments are made in the name of the members and are not allowed to be specifically earmarked. The members’ benefits will be determined by the trust deed and / or scheme rules.

The trustees of a SSAS also have additional reporting duties, as they are effectively the scheme administrator. This can include:

• registering the scheme, providing returns of information and reporting events to HMRC
  
  
• registering with the Pensions Regulator and providing scheme returns (unless it’s a single member SSAS)
  
  
• operating tax relief on contributions and paying any charges due
  
  
• providing member information.

What investments are allowed in SSAS?

SSASs can invest in a similarly broad range of investments as SIPPs. Allowable investments may include:

• UK and overseas stocks and shares
  
  
• Unlisted Shares
  
  
• Unit Trusts
  
  
• Investment Trusts
  
  
• Open ended investment companies (OEICs)
  
  
• Insurance company funds
  
  
• Deposit accounts
  
  
• Gilts and overseas securities
  
  
• Investment grade gold bullion
  
  
• Commercial properties
  
  
• Cash
   

As a SSAS is an investment regulated pension scheme, a tax charge will be incurred if they invest in:

• residential property
  
  
• 'pride in possession' assets such as paintings, antiques, vintage cars and fine wine
  
  
• non-investment grade gold bullion.

Finance Act 2004Sch 29A Part2

Shares can be bought in the sponsoring employer. However, in an occupational pension the amount of shares in a sponsoring employer can’t exceed 5% of the total value of the fund. If there’s more than one sponsoring employer, the SSAS may invest up to 5% of the fund in each employer up to a maximum of 20%.

A SSAS can make a loan to the sponsoring employer. There are certain conditions which apply:

• the loan must not exceed 50% of the net market value of the assets of the scheme this is worked out as per the example for SIPPs.
  
  
• the loan must be secured by a first charge over assets of equivalent value
  
  
• the term must be no longer than five years; and
  
  
• interest at no less than 1% above the average of the base lending rates of the six leading high street banks must be charged.

When HMRC may de-register a scheme

Section 158 of Finance Act 2004 introduced a new criteria allowing HMRC to de-register a scheme if it appears, after 5 April 2018, one or more of the sponsoring employers is a dormant company, meaning the company has been dormant for a continuous period of one month.

The full grounds for HMRC de-registering a pension scheme are set out in Pensions Tax Manual.

PTM033200

What are the differences for SIPP versus SSAS?

Since 6 April 2016 there aren’t as many differences between SIPPs and SSAS as there once was. Both have a wide range of investment powers and are classed as investment regulated pension schemes. The main difference is that SSASs are occupational schemes and therefore there are more regulatory duties attached. A SIPP can't make a loan to a sponsoring employer and within a SSAS there are limits to share ownership in a sponsoring employer that don’t apply to a SIPP. However, with a SIPP, any purchase of shares in a company controlled by a member may be taxable.