It might sound too good to be true, the prospect of enjoying a holiday home in the sunshine while saving for retirement, but this will be possible when the pension rules change on ‘A-Day’ – 6 April 2006.
For the first time we will be able to invest in residential property within our self-invested personal pensions (SIPPs) in the UK and abroad. A dream come true surely for most of us property-obsessed Brits.
SIPP investors will benefit from full UK income tax relief on the purchase price of the property before going on to collect rental income tax-free in the pension fund. Any profits made from the sale of the property will
also be free from capital gains tax in the UK.
If the government really wants to encourage people to save for their retirement then, with so many people favouring property over stock market investments, this is a great way to do it.
What’s more, the pension fund will be able to borrow to invest so buyers can gain access to holiday homes and other properties that would have otherwise been out of their reach.
SIPP scepticism
So where’s the catch? Well, there has been a certain amount of negative feeling regarding SIPPs and how far they will actually go in changing the pension landscape and allowing people to invest in homes as part of their retirement planning. But there are ways around a number of the key issues.
It is correct to point out that the borrowing rules for SIPP investors will be changing on ‘A-Day’ from the current 75 per cent of the purchase price to 50 per cent of the existing pension funds.
But do not assume this will price most people out of purchasing holiday homes overseas within their pension funds as this would be to assume that other rule changes do not also have an affect on people’s decision-making and the way they fund their SIPP.
Where previously investors could borrow against the purchase price of the property, after 6 April next year they will be able to borrow up to 50 per cent of pension scheme net assets.
All sorts of assets such as art or existing buy-to-let properties can be migrated into the pension thereby counting towards the total value of the fund and increasing the borrowing potential. In addition, it is looking increasingly likely that the government may even increase the borrowing capacity of SIPPs to beyond 50 per cent at some point after ‘A-Day’.
Using your assets
Another example of how the 50 per cent borrowing limit can be less restrictive than it seems is by moving an existing asset into the scheme. Many people have existing holiday homes they have bought for cash using funds borrowed from their main home.
If these were injected in bit-by-bit each year by a husband and wife as a contribution limited to their earnings that year, they would significantly add to their pension fund and be rebated the entire tax they had paid that year as a contribution to the fund as well.
This type of addition would lift pension net assets significantly and would allow borrowing of more realistic levels for another property investment within the fund.
It is true that investors will need to pay rent at the going rate when they make use of the holiday home themselves but this money will be pouring straight back into their own pension pot.
It needn’t even be an additional cost since investors can simply pay their pension contributions for that year in the form of rent. It is also the case that SIPP investors are likely to have to pay capital gains tax in the country they have invested in but there are ways of reducing this dramatically by setting up a company structure – a relatively inexpensive and straightforward process.
Drawbacks
Admittedly there are some drawbacks that cannot be worked around. The pension fund will be the legal owner of the property, not you. It will hire a property management company to look after it.
If the managers says the property needs, for example, a new plumbing system, the cost will be met by your pension whether you like it or not. You will also need to pay annual fees to a valuer to satisfy the SIPP manager (in effect a trustee of your pension) that you are not undervaluing or overvaluing the property.
But we will undoubtedly see many people switching to SIPPs because of the freedom to buy homes. The likely knock-on effect on the property market is a new surge of buying interest which could buck the downward trend well before April.
Making a success out of the potential property investment opportunities within SIPPs requires a greater focus on locking away personal assets and savings for the long-term purpose of retirement income planning – which cannot be a bad thing.
Stuart Law is managing director of Assetz
