Putting borrowed money into an SIPP

Question

I am employed and have about three years' salary in a stocks-and-shares ISA (an investment from which dividend income and capital gains are tax-free). I generally save £600 a month.

The bank associated with Tesco, the largest supermarket in England, will lend me £20000 for three years at 3.4%, so a repayment of £584.70 a month, a total cost of £21049.20.

If I put money into an SIPP (a pension fund in which I get to choose what investments are made), the government will give me a tax refund of 60% of that money.

Why shouldn't I borrow the 20k, put it in the pension fund, and use the money I'd otherwise be saving as repayment on the loan? I get the £12000 tax refund (which I think I'm allowed to recycle through the pension fund and do the same thing again with; and in the very least which I can stick in the place I'd otherwise be saving the £600/month), I get stock-market gains on the money in the fund, and if I screw up utterly the absolute worst I have to do is use less than half of the money in the ISA to repay Tesco.

Answer 1

You may have misunderstood some parts of the system.

If you make a pension contribution in any given year, the tax relief is based on your income for that year - the gross pension contribution is subtracted from your gross income and you only end up paying tax based on the reduced gross income.

So if the higher rate threshold is £40K, you have income for the year of £65K, and you make a gross contribution of £25K, then you'll get tax relief at 40% on the whole contribution, i.e. £10K. If your income for the year is less, e.g. £50K, then you'll get tax relief at 40% on £10K and at 20% on the other £15K, i.e. £7K.

So if you're significantly into the higher-rate band, it's usually not worth making a contribution large enough to reduce you to basic-rate tax - better to wait till the next tax year for the rest.

Overall, while you probably could do what you suggest subject to the caveats below, why not just spread the pension contribution over the three years, rather than making it all up front?

If you are confident you can invest the money at better than the 3.4% interest on the loan, then it might make sense to borrow, but you should be pretty clear that you're deliberately borrowing to invest (otherwise known as investing with leverage). Or you might know that your income is going to drop next year.

Another clarification, as your comment on another answer mentions: basic-rate tax relief is claimed directly by your pension provider ("relief at source"), whereas the higher-rate part of the relief comes straight to you via your tax return. So for the above £25K gross contribution example, you'd hand over £20K initially and then get £5K back at the end of the tax year, leaving you with £15K less in your pocket. If you did want to make a £20K net contribution and had enough higher-rate salary to cover it, the gross contribution you'd end up with would be £33,333, and you'd need to find £6,666 more temporarily.

Note that there are also limits on the annual contribution you can make of £40K (the "annual allowance"), but you can carry forward allowances from three previous years so it's very unlikely to be relevant.

Answer 2

You're creating more liabilities for yourself in the future, although yes this could definitely be a profitable move for you.

However, some small mistakes you made, from what I can see using the tools at Hargreaves Lansdown.

The first, is that the government relief would only be 20%, not 60%. The second is that the tax relief goes directly into the SIPP, it's not something you get given back to you in cash.

In order for this to be worthwhile, you need to be sure that you can make a post-tax gain of more than 3.4% on this money per year - which should be very feasible.

It sounds like you have enough security that you could afford to take this risk.

Answer 3

If it were possible to take a loan out for a SIPP investment in the future .. I would suggest having an equivalent invested amount already in an ISA .. simply to cover you in the event of a job loss including additional cash in a deposit account.

Secondly .. to increase your chances of success with this strategy I would also suggest doing this when the odds are more in your favour during the bottoming out cycle of a market crash.

Thirdly .. it depends on how knowledgeable you are about investment , I would suggest being invested globally & in many different sectors to take advantage of various price movements.