With my background in Sipps and Ssas I have spent many years hearing that ‘My property is my pension’ and ‘I’d quite like to combine the two.’
People often see this as a simple case of increasing their property portfolio but there is more to it when you factor in all the pensions legislation that surrounds these types of investment.
Buying a property with a pension fund has many tax benefits. First, the money used to buy the property will have received tax relief on it, which makes saving for the property in the first place a lot easier, especially if there are employer contributions involved.
The employer contributions will also have been eligible to receive corporation tax relief, which can be a real benefit for owner-managed firms.
On the purchase of the property the usual taxes apply, such as stamp duty land tax and VAT, although in many cases the latter can be reclaimed by the pension scheme.
The greatest benefit comes when rental is received into the pension scheme. If it has been received personally, it’s tax free rather than subject to income tax. These funds can then be used to pay off a mortgage, if there is one, or to build up additional funds for retirement and invest accordingly.
Yet here also lies one of the risks. During the current pandemic we have seen shops close and more people work from home, so the need for some commercial properties has dropped. Many tenants have requested payment holidays or even reduced rents, all of which can have an impact on planned retirement income.
We often caution against people putting their whole pension into a property and borrowing the maximum, due to the issues surrounding non-payment of rent. The current situation strengthens this argument. You don’t want to see the value of the pension eroded with no rental coming in but a mortgage to pay.
On a more positive note, if and when the property is sold there will be no capital gains tax to pay on the increase in value, which means that more is kept in retirement savings.
What’s allowed?
Let’s revisit what can and can’t be held. At its simplest, only commercial property is allowed to be held in a pension without incurring tax charges. However, ‘commercial’ in this context isn’t the same as some people may think. Certain buildings, such as a bed-and-breakfast or a holiday let that are technically used as a business, are not classed as commercial when thinking about pension schemes.
A good rule of thumb is to think: if you could live in it, it is residential. However, as with most pension legislation, there are exceptions to the rule to watch out for.
Allowance issues
Property rental income isn’t factored in to the annual allowance, which is good news for those still impacted by the tapered annual allowance. Regular income provided from rental can therefore be a steady way to continue to grow the funds even if contributions are limited. The same applies for those who are subject to the money purchase annual allowance. However, as mentioned above, rental is in no way guaranteed, as is the case with any investment growth.
Growth in pensions isn’t restricted, although funds in excess of the lifetime allowance will be hit by an LTA charge of up to 55 per cent (or 25 per cent if taken as taxed income). You can’t just switch off the rental once you hit the LTA, and unauthorised payment charges could total 70 per cent of the unpaid rent – significantly worse than the LTA charge.
Taking benefits
There are often concerns about the liquidity of property investments when a member wants to retire but, if managed well, this can be mitigated. There is always the option to sell the property at retirement, but this could be at a bad time in the market or it may be a property linked to a business the member still retains.
The pension freedoms have helped a little with the access to pension benefits, particularly regarding death benefit options, although access to the pension commencement lump sum will clearly be an issue if there isn’t any cash in the pension.
Pension members often need a good steer on how to invest their pension in property, which is a specialist area, so don’t be afraid to talk to your provider of choice very early to avoid any nasty surprises.
Claire Trott is head of pensions strategy at St James’s Place Group
