The property vs pension debate has again been making the headlines. Recently, we’ve heard Bank of England chief economist Andy Haldane nail his colours to the property mast.
Interesting views from someone who confesses to “not being able to make the remotest sense of pensions”.
In the pension corner, we’ve had former pensions minister Ros Altmann extolling the virtues of pension over property via her blog.
My question is, does this choice need to be binary? Is there a best of both worlds solution in the form of commercial property being held via a self-invested personal pension (SIPP) or small self-administered schemes (SSAS) pension scheme?
Let’s examine the pros and cons of this versus a buy-to-let (BTL) residential approach.
Funding and costs
Stamp duty
An individual purchasing a BTL property worth £500,000 would have seen their stamp duty costs increase to £30,000 from April 2016.
The equivalent stamp duty charge on a commercial property of the same value is £14,500. Also, since this could be “funded” via pension savings if held within a SIPP/SSAS, the “net” cost could be as low as £8,700 – a whopping 71% reduction.
Funding
Clearly, a BTL purchase would need to be funded via capital an individual holds – with no tax relief available to boost purchasing power.
Let’s consider a hypothetical example…
Mr. Black has a pension fund of £350,000 but wished to purchase a commercial property within his SIPP valued at £500,000. He confirms that he has made contributions of £5,000 per annum over the last few tax years but has scope to “carry forward” unused relief from those years.
This, in turn would allow up to an additional £150,000 contribution to be made in the current tax year bringing his fund to the £500,000 required (ignoring costs for purpose of illustration).
The funding of such a contribution would either attract income tax relief at Mr. Black’s highest marginal rate (should he fund this “personally”) or corporation tax relief if funded via his company. Either way, the net cost of reaching the required £500,000 is significantly less due to the impact of tax relief.
Allowances
This April’s changes saw BTL landlords suffer significant reductions on “wear and tear” allowances and mortgage interest tax relief that can now be claimed. Wear and tear costs now need to actually be incurred rather than the previous annual allowance for such costs.
Similarly, higher rate taxpayers will only be able to claim basic rate tax relief on mortgage interest costs – this change being phased in from April 2017.
Of course, it is also worth remembering that rental payments under a BTL property are subject to income tax, which would not be the case with pension held commercial property rental.
Capital Gains Tax (CGT)
A key benefit of holding commercial property within a SIPP/SSAS is that no CGT is payable upon the future sale of those premises. The impact of this is best illustrated by means of an example.
Assume an individual had an option to purchase either a BTL property or an office block five years ago – each costing £500,000.
Taking annualised returns into account the current value of each would have been:
- BTL £842,000
- Office £937,000
If the client wished to sell the BTL property, this would be subject to a 28% charge – i.e. about £78,700 (allowing for £50,000 costs and annual CGT allowance).
The commercial property would suffer no CGT liability within the pension wrapper.
Liquidity concerns?
Regardless of which option is taken, having all your eggs in one basket is never to be recommended. If an investor holds the majority of their assets in a BTL property which suffers a void period for example, they may find it difficult to meet mortgage payments and/or generate income if any mortgage has been repaid.
If instead, however, they held commercial property within SIPP/SSAS then it is possible to structure these to include other directors or family members, for example. Hence the elder members of the fund may have more flexibility in terms of how they draw income – e.g. perhaps utilising liquid funds which has accrued for the younger members in return for a share of the property value.
And if the worst happens? Individuals who face financial difficulty are likely to come under pressure to release any equity in the BTL property to creditors. However, property held within a pension trust is ring-fenced from any creditors the individual may have.
On death, an individual’s BTL property will form part of their estate for inheritance tax (IHT) purposes – and hence potentially subject to 40% tax charge
Commercial property held within a SIPP/SSAS, however, would not be subject to IHT. Beneficiaries could either draw an income from the property from any rental yield it generated, or even “receive” the property as part of the settlement of death benefits.
Taking into account our earlier comments on CGT, it can be seen how inter-generational cascade of property can provide significant tax savings.
Mark Canning is head of proposition and development at @SIPP
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