Type of pension vehicle
Self-administered pension schemes are used as the pension vehicle for the purchase of the property. There are two types of self-administered scheme – self-invested personal pension plans (SIPPs) which are for individuals, and small self-administered schemes (SSAS), which are for companies. These are known collectively as investment regulated pension schemes.
SIPPs are personal pension plans that allow the individual to choose where his or her pension savings are invested, rather than leaving that decision up to the pension fund manager. The range of investments that can be held in a SIPP is wider than those permitted in a personal pension scheme, and importantly includes investment in commercial property, an option which is not available under a personal pension plan.
Contributions are paid into the plan either by the individual or by his or her employer.
These attract tax relief. The SIPP provider acts as the trustee of the SIPP and manages the SIPP on behalf of the members. Where property is purchased through the SIPP, it is the trustees who are the legal owner of the property.
It is not necessary for the SIPP to be able to buy the property outright as it is permissible to borrow up to 50% of the value of the property. This is particularly useful if the pension fund is not large enough to meet the full cost of the property.
It should be noted, however, that it is not possible to draw on a SIPP before age 55.
What type of property
A SIPP is permitted to own a commercial property outright, but not a residential property. While it is possible for a SIPP to invest in a residential property, this can only be done as a small part-owner where the property is not for personal use and via a genuinely diverse commercial vehicle, such as a real estate investment trust (REIT). The restrictions on residential property mean that in most cases SIPP property investment is restricted to commercial property.
Permitted investments include business premises, factories, offices, shops etc., as well as hotels, care homes and prisons. Investment in student halls of residence is also permitted, but not flats or houses let to students.
Where a commercial property also has a residential element, for example a shop with a flat above, the residential element can be held by the SIPP as long as it is not occupied by a member of the SIPP. Thus it is not possible for the shopkeeper to buy the flat and the shop through his SIPP and live in the flat, although the SIPP can buy the shop and the flat and let them to an unconnected shopkeeper.
Tax relief is available for contributions to registered pension schemes, and as such contributions to SIPPs benefit from relief. Tax relieved contributions can be made to the highest of 100% of earnings and £3,600, subject to the availability of the annual allowance. The annual allowance for 2011/12 is set at £50,000. Unused allowances can be carried forward for up to three years, providing an effective limit on contributions of £200,000 over a four-year period where earnings permit.
The ability to make contributions in respect of non-earners up to £3,600 gross (£2,880 net) a year mean that contributions can be made in respect of children and non-working spouses to further build up the fund. Tax relief is given at source on the contributions regardless of the fact that the contribution is made in respect of a non-taxpayer, providing an additional benefit as the fund has the benefit of contributions of £3,600 for a cost of only £2,880.
Contributions made by individuals attract tax relief at the individual’s marginal rate. Where contributions are made by the company, these are deductible for corporation tax purposes.
Any rental income received by the pension fund in respect of the property is tax-free. A further benefit is that any capital appreciation of the property whilst in the pension fund is free of capital gains tax. On retirement (age 55 or above), 25% of the value of the fund can be paid as a lump sum. Should the SIPP member be unfortunate enough to die before retirement, the whole fund may be paid as a lump sum, free of inheritance tax.
Bill Brown runs a family business with his wife distributing speciality cheeses. The business was initially run from the Brown family home. However, due to expansion, the family decide to move the business to dedicated business premises.
Mr Brown has a SIPP, of which he, his wife and his three children are members. Mr and Mrs Brown have each contributed personally to the SIPP and contributions have been made by the company. Each year, Mr Brown also makes contributions of £3,600 (gross) in respect of his children. The contributions attract tax relief and as such represent a tax-efficient investment.
Mr Brown finds suitable business premises and decides to purchase the premises through the pension SIPP. The fund is not sufficient to purchase the property outright, so he borrows 30% of the purchase price.
The property, which is owned by the SIPP, is let to the company for a rent of £3,000 a quarter. The rent is tax deductible in computing the profits of the company, but rather than going to a third party it is paid into the SIPP (which will benefit the family). The rent is tax-free in the hands of the SIPP.
The rent paid into the SIPP helps to build up the value of the SIPP. This may provide the opportunity for the SIPP to lend money to the company should it need it in the future. If this route is taken, the interest paid on the loan is paid into the SIPP, rather than being lost to a third party.
If the SIPP decides to sell the property, the fund benefits fully from any appreciation in value as there is no capital gains tax to pay on disposal of the property.
As demonstrated by the above case study, buying commercial premises through a SIPP can be a win-win situation, partly as a result of the tax benefits available and partly because any rent paid for the commercial property is not lost to a third party. The usual health warnings apply and professional advice should be sought if contemplating an investment of this nature.
Consider buying or transferring your business premises to a SIPP to take advantage of the benefits on offer.