How to Buy a Property Using a Pension Plan
Contents:
- Introduction
- Direct Property Investments
- Commercial Property
- How It Works
- Benefits of Using Your Pension
- Things to Consider
- Types of Pensions You Can Use
- Using Pensions to Buy Property
- The Role of the Trustee
- Summary
Introduction
Buying a property with your pension can be an attractive option, one that is popular with many pension investors. There are several ways you can use your pension to buy a property or properties and there are significant benefits, in certain cases, for doing so. Within this guide we will outline all the main factors involved and show you how you can place a property into a pension. We will also explain all the various restrictions, and what you can and can’t do.
In addition, we will cover the two types of pensions that are generally used for direct property investments and the role of advice in the process.
Direct property investments
We use the term ‘direct’ property investment to describe the situation where you own an individual property or series of properties yourself (through your pension), as opposed to an ‘indirect’ property investment, where you hold a property fund, managed by a fund manager within a pension plan.
A direct property investment is one where you buy commercial property such as an office building, a shop, or a factory, that you own through your pension. And your pension plan/scheme is registered as the owner.
The indirect alternative is where you invest some of your pension plan/scheme monies into a fund, where there is a basket of properties held and owned by a fund manager, and you are an investor in the fund, getting a return based on how well they choose and manage their portfolio of properties.
In certain cases, a fund may invest in residential property. But you cannot do so directly via your pension.
This guide focuses solely on the situation where you wish to place an individual property into your own pension, or join in with others to create a syndicate, or you buy a series of individual properties.
A DIRECT PROPERTY INVESTMENT IS WHERE YOU BUY COMMERCIAL PROPERTY THAT YOU OWN THROUGH YOUR PENSION
Commercial property
You can only put commercial property directly into your pension and retain the tax benefits that pensions provide. You cannot put residential property into a pension, so any house you own, including buy-to-let properties are excluded.
Technically, this is not 100% correct as you could do so in theory, but you would lose all the tax privileges of the pension. You would also struggle to find a pension trustee to support this.
Commercial property is normally considered to be:
- Offices and business units
- Shops
- Factories, warehouses, and industrial units
- Nursing homes
- Pubs
- Hotels
- Land for commercial development
- Agricultural land
- Forestry
- Marine berths
This is not intended to be an exhaustive list, as there are potentially other commercial types of building or land which may qualify.
There may be hybrid situations (e.g., where a flat sits above a shop, so part commercial, part residential).
Such hybrid situations need to be considered on a case specific basis.
It is exceptionally important when considering putting any commercial property investment into a pension to get our expert advice and help.
Transactions that fall foul of the regulations in this area can cause all the tax benefits of the pension to be lost and potentially incur additional costs.
YOU CANNOT PUT A RESIDENTIAL PROPERTY INTO A PENSION WITHOUT LOSING THE TAX BENEFITS OF THAT PENSION
How it works
Buying a property with your pension means taking the sums you have in your scheme and using these to purchase the property you have identified.
You instruct the trustees of your pension plan to make the transaction on your behalf.
You may not have enough money in your pension to buy the property outright, in which case you can arrange for a commercial loan to bridge the gap.
A commercial lender then loans the sum to your pension plan.
For example: You wish to purchase an office building for £400,000.
You have £200,000 in your pension.
You arrange for the other £200,000 to be borrowed and loaned to the pension, with the office building as security.
(The above is a simplified description, there will also be costs involved that need to be factored in).
A Commercial Loan to Individual Pension
Commercial Loan to Syndicates
Borrowing is permitted, on commercial terms.
Likewise, you are permitted to buy a property where your business is the leaseholder.
This leads to the attractive potential position where your business is paying rent to your pension.
All transactions, to be valid, must be on commercial terms. This means you must ensure the levels of rent and the interest payable on a loan are at levels considered to be the market ‘norm’.
Another example, which is a popular situation, is where one or more individuals, such as business partners/associates or family members club their pensions together to buy a property.
For instance, a property worth £400,000 could be shared between two partners who each allocate £100,000 and the other £200,000 is borrowed.
The benefits of using a pension to buy a property
The first major benefit is a simple one – tax relief!
Pensions are amongst the most tax-efficient financial products you can access for long-term investing purposes.
Any contribution you make to a pension plan attracts income tax relief and any gains you make in a pension are free of capital gains tax.
Certain pensions also have a potentially favourable Inheritance Tax status.
The second benefit is that you have direct control.
If you invest into a property fund, run by an insurance company or a specialist fund manager, you are delegating control, decisions, and management to that manager.
If you buy one or two properties yourself and hold these in your pension, you make the decisions and you can manage the position.
The third benefit is one where you buy a property you already occupy, either in part or in whole, as the commercial tenant. Or you buy a property, and your business becomes the tenant.
Leading to a situation where the rent your business pays, goes to your own pension.
The fourth benefit is that if you were minded to buy a property directly (not with your pension) the costs of the purchase and the ongoing management costs would be incurred directly, but when you do so through your pension, the costs are born by the pension plan/scheme.
Things you need to consider
The benefits outlined above come with some risks and factors you need to be wary of.
Clearly if you put a substantial amount of your pension into one property or a small selection of properties, then you are NOT diversifying in any meaningful way. If that narrow investment approach doesn’t work out, you may have overreached.
Similarly, many pension investors will own their own home and already have a significant exposure to the property market and its general ebbs and flows.
Adding property via a pension could be seen to be doubling down.
Although buying property through your pension provides greater control etc. it will inevitably raise the pension running costs higher, and potentially much higher, than using a fund manager’s property pension fund.
Finally, you need to be wary of how illiquid a property holding may be. Your pension is primarily a vehicle to help you accrue sums for your retirement.
You don’t want to be stuck with a property you cannot sell.
Unlike many other investment options you have, offloading a property can be a challenge if you wish to release monies in your retirement.
Related to this is the potential issue of not being able to let the property if the market turns or having a tenant who fails to make rental payments.
The two types of pensions you can use
There are two types of pension scheme suitable for property purchases:
Self-Invested Personal Pensions (SIPPs)
These are personal pensions, and available to everyone.
They are different to other types of personal pensions, as they allow for ‘self-investment’ and for the pension investor to control where the money is invested, including into permitted direct investments such as commercial property.
If you have an existing personal pension, you can transfer this to a SIPP – although this may not always be desirable or sensible.
If you have a defined benefit pension, such as a final salary company scheme, this can also, in certain circumstances, be transferred to a SIPP, this is rarely advisable except in rare cases.
Note: not all SIPPS allow for direct and self controlled commercial property investment. This is always worth checking with any SIPP provider company before using them.
Small Self-Administered Schemes (SSASs)
These are self-managed employer schemes.
Typically used by family businesses and smaller companies. A business can only have one SSAS scheme running, and it cannot have more than 11 members.
Members are the beneficiaries of the scheme, and must be employees of the company (e.g., its directors) or family members of employees.
Using the pensions to buy property
Which type of pension scheme you may wish to use will be very case dependent, based on your circumstances and that of your business (if you have one).
The pros and cons of using one or the other come down to technical matters that you should discuss with an expert.
The technical details and full scope of these two types of schemes are not the core subject of this guide, which is focused on property investing.
Therefore, to find out more about how these schemes work, and which would be suitable for your situation, please ask for our help and we can outline further.
The role of the pension trustee
With a SIPP you will need to find a SIPP Provider and that company will act as the trustees of your pension.
It is possible with a SSAS that you can act as the trustee. Or you can use a third party SSAS provider to do so for you.
The role of the trustee is to ensure compliance with all pension rules and to arrange all transactions and in effect to be the legal owner of any asset within the pension on behalf of your pension.
Although it is your pension, you delegate these aspects to your trustee.
A trustee is a very important cog in the wheel because the loss of the tax benefits can be very punitive, and ensuring compliance is vital.
THE LOSS OF THE TAX BENEFITS CAN BE VERY PUNITIVE, AND ENSURING COMPLIANCE IS VITAL
Summary
Many pension investors use their pensions to invest directly into property.
The tax benefits of a pension work well with commercial property as rental income can accrue without tax liability, and any appreciation in the value of a property accrues without any tax liability.
The fact that the pension can borrow money to top up the potential purchase value also offers attractions, bringing otherwise out-of-reach property into the zone of affordability in the right circumstances.
Affordability can also be achieved by the possible clubbing together of different individual’s pensions.
The leverage effect of borrowing can inflate returns, provided the property performs well and increases in value.
Having direct control and choice over the investment, plus the possibility of buying a property your business leases, can be very valuable in the right circumstances.
All these benefits must be considered against their corresponding risks, and in the knowledge that if things don’t work out as planned or anticipated, a pension can be decimated by this approach.
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Readers should not rely on, or take any action or steps, based on anything written in this guide without first taking appropriate advice. Interface Financial Planning Ltd cannot be held responsible for any decisions based on the wording in this guide where such advice has not been sought or taken. The information contained in this guide is based on legislation as of the date of preparation and this may be subject to change.