You may think of pensions as low-risk investments. But did you know that you can potentially improve what you make in your Sipp by using debt? It is possible to borrow up to 50 per cent of your fund's value.
You can also borrow money to buy holdings that are themselves geared, which means that you could have an effective gearing level of much more than 50 per cent of your fund. That said, you should be aware that, while using gearing should boost returns in a rising market, it exacerbates losses in a falling one.
Commercial property
The most common use of gearing in a Sipp is for investment in commercial property. Whereas you could previously borrow up to three-quarters of the value of your pension pot, you can now borrow only 50 per cent your fund's value. This could well restrict the size of the investments you can make. For example, with a £100,000 Sipp, you could not buy a property worth more than £150,000 and, in practice, rather less after transaction costs.
On the other hand, you can now put up to 100 per cent of your annual income into a Sipp – capped at £225,000 in the current tax year – so you could boost your pot before you invest. You can also join other investors to buy a property together. One popular option is for professionals to buy their own business premises, turning their office into their pension fund. Rent must be paid to the Sipp, but this would be offset against pre-tax profits.
Loans on property are available through full Sipp providers and are typically charged at 1.5 to 2 per cent above the Bank of England base rate.
Equity investments
A few Sipp providers will also let you borrow against existing investments in your Sipp to allow you to gear up your exposure to other investments, such as shares and funds. Killik & Co and SG Hambros offer Sipps where you can borrow to invest in most eligible Sipp assets. Not all eligible assets may be allowed, though. For example, Killik & Co does not allow unlisted investments to be held due to the difficulty of valuing them. Killik & Co's gearing facility costs 1.65 per cent above the base rate.
"It's worked well but we make it very, very clear that clients could potentially lose the whole value of their Sipp, if it blows up and the gearing goes the wrong way," explains Malcolm Cuthbert of Killik & Co.
Hotbed allows you to gear up investments in unitised private equity deals (as well as unitised commercial property) in its Sipp. Hotbed's private equity deals are themselves normally geared, with typical borrowings of three to four times pre-tax earnings. You may be able to invest in a Hotbed deal through another Sipp provider, too, although many do not allow direct private equity to be held. Gary Robins, of Hotbed, points out that deals come pre-approved for eligibility by its Sipp administrator Alliance Trust.
Alternatives
You could also use your Sipp to buy holdings that have gearing of their own. In fact, you could borrow 50 per cent of your fund’s value to invest in geared holdings. One popular area is limited partnerships – fixed-term, geared investments that invest in areas such as property and private equity. Many investment trusts gear up to boost returns, too, although most funds restrict themselves to gearing of no more than 30 per cent.
Or you could gear up your returns in your Sipp by using derivatives. Many providers allow contracts for difference, although you might have to outsource to a specialist broker, such as ODL Securities, to trade futures, options and covered warrants. Spread-betting, however, is not allowed in Sipps.
