From Special Report: At Retirement - May 2012
The options of what to do when “the computer says no”
Investment in commercial property has traditionally been a core attraction for many self-invested pensions, and the merits of bricks and mortar in a pension arrangement are frequently discussed.
Not only can regular tax-free investment growth arrive through rental payments, in the right market conditions we have seen many properties also benefit from capital gains free of tax where the property value has increased. Right now property values are viewed by some commentators as being at (or close to) rock bottom, so it is arguable that now may be a good time to invest.
However, while commercial property may be attractive, there is a major problem faced by some investors: lack of bank funding.
Property purchases can be funded in many ways through a pension arrangement: using existing funds within the arrangement, consolidating benefits from outside the arrangement, borrowing and /or contributions to the scheme.
Prior to the reduction in annual allowance, contributions up to £255,000 could be made without incurring tax charges. By carefully planning changes to an individual’s pension input period, two tax years’ annual contributions could be paid closely together subject to certain conditions. The result of this would be over £500,000 being paid that could effectively be used to fund a property purchase.
However, with the reduction in annual allowance the scope for funding property purchases with contributions has been restricted somewhat. Even where carry forward is available, and with the ability still to change the pension input period, the funding is effectively halved. The most that could be contributed would be £250,000. £150,000 from carry forward with £50,000 from the current tax year followed by a further £50,000 when the next pension input period opens. Where contributions have been made in the previous three years this would impact carry forward available and reduce the £150,000.
Demand for property to be purchased under Sipp and Ssas has remained strong and as already noted interest is very high, especially as most commercial property purchases are known to the investor who can normally spot the opportunities for increasing yields or capital growth.
It has therefore been essential to work with advisers and their clients to find alternative funding options and ways to bring property under the tax-efficient umbrella, particularly where bank funding is less easily achieved.
There has been an increase in joint property purchases with a third-party outside the Sipp. Joint purchase with two or more members remains popular where members pool their pension funds under the Sipp to invest in property, but we are seeing a shift towards purchases with the member personally or the member’s company. In some cases we are seeing part purchases of properties already owned by the third party.
These purchases, if dealt with correctly at outset, should be no more complex to administer than a regular joint property purchase with Sipp members.
The key to their success is ensuring that all parties are in agreement on how these will be operated and are aware of the legislation governing the part of the property that is owned by the Sipp. It is prudent to put in place a Declaration of Trust governing the ownership.
This will ensure that the responsibilities of both parties and the powers to initiate a sale are clearly outlined.
In many cases, although the property is being purchased jointly, the intention will be for the Sipp to own the property in its entirety at some point in the future. This would follow the pension pot building either through contributions in future years, transfers-in, new members joining such as spouse or business partner, investment growth through rental income or a combination of a number of these.
From an adviser’s perspective, when planning property acquisitions of this nature it is important to build in future costs. There is undoubtedly more legal work, and of course stamp duty must not be forgotten, as this is levied on the value of the share of property moving from one party to the other.
These cases can become more complicated where the property is subject to VAT. In these circumstances all parties will need to register for VAT together as if a partnership. It should be noted that this is a requirement even if all parties are not in partnership for any other purpose and this will not form a legal partnership as such.
As the VAT administration will be carried out on behalf of several distinct parties, to overcome the practical aspects of the joint VAT partnership it can be good practice to engage with an accountant to carry out the VAT administration on their behalf. This would generally not be a consideration for joint Sipp member property purchases as the owner will simply be the Sipp Trustee.
The above is all very well where funds are available to facilitate contributions to the pension (and of course the third party will also require funds for their share of the purchase).
Borrowing is an option available and short term VAT loans can also be used to aid the purchase, remembering that the limit of all borrowing under the Sipp is restricted to 50 per cent of the net fund value.
As the VAT on the purchase will be reclaimed generally within six months of the purchase taking place then banks may be willing to lend on the basis that part of the funds being borrowed will be repaid in the shorter term. It is worth noting that the VAT loan taken by the pension fund should not be for more than the VAT attributable to the portion of the property being purchased by the scheme as funds should not be used from scheme borrowing to finance the third parties’ property purchase.
What should not be forgotten is the use of in-specie contributions; in particular this could be useful where the goal is to move the property fully under the Sipp, and this could be combined with available Sipp cash to fund a buy-out of the remaining property value from, for example, the company or the member.
In-specie contributions can be used over the longer term to fund further property ownership by the Sipp and consideration should be given to doing this after a period where sufficient carry forward is available to move a significant portion or ideally all of the property to the Sipp. This would help keep legal fees and potential administration costs to a minimum.
Gayle Murray is Sipp technical manager for Xafinity