Many times we hear “my property is my pension” where people are talking about their home or buy-to-let portfolio. However, by combining property and pensions greater tax efficiency can be achieved.
Putting a property into a pension has many tax benefits. Firstly, 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 also employer contributions involved. The employer contributions will also have been able 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 VAT can be reclaimed by the pension scheme.
The real benefit comes when rental is received into the pension scheme which is tax-free, rather than subject to income tax if it has been received personally. These funds can be used to pay off a mortgage if there is one or build up additional funds for retirement and invested accordingly. This is all the more important where members are hit by either the tapered annual allowance or, in some cases, the money purchase annual allowance.
Then, if and when the property is sold, there will be no capital gains tax to pay on the increase in value.
All this makes for very efficient investing, but since it is a pension there are other issues to consider.
Know the investment
Only commercial property is allowable in a pension without incurring tax charges. This doesn’t mean a property that is used for commercial gain, such as a buy-to-let where the rules are much stricter. A good rule of thumb is to think if you can live in it, it is residential. However, providers all have their differences and so it can’t be assumed that it will be excepted. And of course, there are exceptions to the rules, so some residential elements are allowed.
Deciding on the property is key. Pension providers rely heavily on professionals and members to be their eyes and ears with regards to properties, so knowing if there are likely to be any issues at the outset is a really good start.
Borrowing to purchase a commercial property is fairly normal, but this does come with its own risks. Repayment of this borrowing needs to be carefully planned. Overstretching the pension and leaving no contingency is a real risk. This has become even more evident over the last year with many tenants not being able to pay their rent and rent even being written off in certain circumstances. There have been options for a mortgage holiday, but it is still likely to be the client’s pension at stake eventually, which can be very stressful.
The lack of liquidity of a property means that other liquid assets or cash needs to be available to pay fees and eventually benefits. If the only investment is a property that has a large mortgage, there could well be issues down the line should the member want to access funds. Restrictions may be in place to stop this happening at the outset, but as we have seen, unexpected issues can arise.
Retirement
It is important to remember that properties don’t need to be sold at retirement provided there are sufficient liquid assets in the scheme to pay any tax-free cash. This should be planned well in advance to avoid any nasty surprises.
Flexi-access drawdown has made drawing funds from a pension with a commercial property even more flexible. Depending on needs, a member could easily draw an income based on the rental being received by the scheme, although any ongoing fees and a buffer for unanticipated costs will need to be taken into account.
Many properties purchased using pension funds are for use as the member’s business premises, which has two clear benefits. If the company can’t afford to buy a property then the rental paid isn’t really being wasted as it is being used to fund the owner’s retirement in the long run. In addition, as the property isn’t actually part of the business, should the business fail or be sold, the property can be retained within the scheme and either rented out to the new owner or to a completely separate entity.
Potential issues
Owners and tenants have experienced their own issues over the last year, with connected party tenants not being able to cover their rent whilst closed. Non-payment of rent when connected can become an unauthorised payment with associated tax charges and writing off debt to a member is more problematic, although not impossible. Care needs to be taken to ensure the appropriate documentation of any decision is made.
This year has shown us more issues with holding commercial property within a pension scheme, but it doesn’t detract from the appeal for many. The art is to factor in the issues and try and cover them off as far as possible. Good advice is key to a great outcome, both from a property perspective and a financial planning perspective.
Claire Trott is head of pensions strategy at St. James’s Place