We recently blogged on the relative advantages of property and pensions as investment strategies. As part of the article, we looked at commercial property and how this can be used to combine the merits of both property and pensions.
Buying a property using a pension fund comes with its own set of rules and isn’t the right strategy for everyone.
Here we look at nine things you need to know if you’re considering using a pension to fund a property purchase.
What type of property
The rules on the type of property that a pension can purchase are fairly tight and do not allow for the purchase of residential property. Any property you buy in your SIPP or SSAS must therefore be classed as commercial. Where a property is classed as mixed use, for example a residential flat above a shop, only the commercial part of the building can be purchased using the pension.
What type of pension
SIPPs are the most common type of pension used to purchase commercial properties but don’t assume that every SIPP allows property purchase. Pension providers usually charge set-up fees, property purchase fees and annual fees that vary significantly from provider to provider. There are also other things to consider when choosing a SIPP provider, including whether there is online access and the capability of the provider of meeting your timescale for the transaction.
Financial planners are able to recommend suitable SIPP providers for the transaction and will assist in setting up and moving funds to a new SIPP where required.
Borrowing
Both SIPPs and SSASs can borrow up to 50% of the scheme’s net assets to fund the purchase of a commercial property.
A property can be purchased irrespective of whether it is your or another business trading from it. However, if you are borrowing to fund the purchase, the lender will need to either be satisfied that your company can afford to pay the rent or that there is sufficient market demand.
Flexible additional funding options
Although the rules on the type of property you can buy are strict, there are a number of methods by which the purchase of a commercial property by a pension can be funded. This opens the door to commercial properties for a wider range of pension holders.
Some of the ways you can fund the purchase of a commercial property with your pension include:
- The pension borrowing money from a bank
- The pension buying the property jointly with another pension – ideal for companies with a number of directors
- The pension buying the property jointly with your company or with another party (including you personally)
Should further cash be accumulated in the pension over subsequent years, buying the remainder of the property could be an option in the future.
Lack of liquidity
One of the main drawbacks of purchasing a property using a pension is lack of liquidity. If the property has not been sold by the time you retire, your pension will potentially have a relatively small amount of liquid assets to draw from. Depending on your financial situation and whether you have other investments to fund your retirement, this may or may not present problems. As such, the purchase of a commercial property with a pension is not suitable for everybody and seeking advice well in advance of retirement age is recommended.
Lack of diversification
A property will usually comprise the majority, if not all, of a pension fund’s assets so by purchasing a property, you run the risk of ‘putting all your eggs in one basket’, or in technical terms, over-exposing yourself to a single asset class. Should commercial property prices experience a downturn, this could have a significant effect on your retirement fund. Diversification between asset classes is generally considered to be one of the fundamental strategies to successful investing and this needs to be carefully considered before any purchase is made.
Lifetime allowance issues
Assessment against the Lifetime Allowance could force the property to be sold during retirement without consideration of whether the timing of the sale is optimal.
No cheap deals
Whilst transactions between connected parties are permitted, such as a pension purchasing a commercial property from the member’s company and subsequently leasing it back, there are strict guidelines. The property must be purchased at market value and any future sale of the property must also be in the best interests of the pension. The rental value of the property must also be evidenced by a report from a Member or Fellow of the Royal Institute of Chartered Surveyors (MRICS or FRICS).
Tax breaks
The tax breaks available for those purchasing a commercial property with their pension are one of the most appealing aspects to consider.
These include:
- No capital gains tax will be payable on the proportion of the property owned by the pension if it is sold in the future
- The pension pays no income tax on rent received
- The rent payable is tax deductible for the company (beneficial if operated by the member’s company)
- Properties held within a pension are not subject to inheritance tax if the pension holder was to die
Buying a property with a pension is a complex transaction and we would always recommend that you seek advice. Our financial planners can help you decide whether a commercial property purchase is right for you, and should you choose to go ahead, ensure that you have a quality pension product in place and make full use of the tax advantages of the strategy.
To speak to one of Gresham Wealth Management’s financial planners, please contact us.