SIPPS and Property
Part 1
How to save tens of thousands of pounds on buy-to-let properties
or your second home
Don’t know about you, but in the past two or three months I’ve
noticed a big change at dinner parties – all the guests, myself
included, no longer bore each other to tears boasting about vast increases
in the value of our homes.
As we know, property prices have stopped rocketing upwards. In some parts
of the country they are falling. However, over longer periods of 20 to
25 years, the market has a habit of smoothing out both good and negative
experiences.
What this is all leading up to is a key point: just as it is vital not
to be stampeded into buying any asset just because everyone else is doing
it, you should not to be put off buying a home simply because prices have
taken a turn for the worse in recent months.
Strangely enough, the Government has decided to make things easier for
people to buy residential property – even giving them tax breaks
to do so. Below, I’ve decided to explain how to take advantage of
this generosity. This article is a bit long, but stick with it –
it isn’t every day that something you read might save you tens of
thousands of pounds.
And all because of... self-invested personal pensions
The tax break comes through what is known as a Sipp, or “self-invested
personal pension”. In fact, you could save many thousands in mortgage
payments over the years by taking advantage of this tax wheeze.
Sipps and how they work
Sipps offer investors the option of making their own investment decisions.
Moreover, they also offer a wider investment scope than traditional pension
funds. Specifically, unlike most other pension schemes, a Sipp allows
you to invest directly in commercial property, including your own company’s
commercial property. It is this latter facet of a Sipp that, until now,
has attracted many investors.
Commercial property and Sipps
If your partnership or company wants to buy a freehold commercial property,
you can either use the existing Sipp funds to purchase the property outright,
or put down a deposit of 25% or more and arrange the balance on a commercial
mortgage.
The property is owned by the pension fund and therefore any growth in
its value is free of income or capital gains tax. In addition, the rent
payable by the partnership or company to the pension fund can be offset
against your earnings.
Because the property is held in a pension, you don't pay any tax on any
rental income, or any capital gains tax on any profit on sale. Remember,
though, that any income you take from your pension in retirement is taxed.
Residential property in a Sipp
You can probably already begin to see the potential benefits of this set-up.
Until recently, sadly, this particular Sipp benefit only applied to commercial
property.
However, what makes a Sipp particularly interesting for everyone is the
fact that from April 2006 – less than 12 months from now –
it will be possible to place residential property in a Sipp.
Unfortunately, at the same time, the amount you will be allowed to borrow
in a mortgage will halve to 50% of the value of your pension pot –
so to buy a house worth £150,000 you must have £100,000 sitting
in your pension.
However, funding limits into a personal pension are also changing, which
means you can stick more into a pension. I’ll tell you more about
that in a minute.
What can you buy exactly?
Any residential property, whether used by you, your family or let on a
commercial basis.
For example:
• A holiday property, letting it commercially for most of the year
but taking a number of weeks holiday in it. You can do this provided you
pay the proper market rent when you use the property
• A property for your children to use while at university, provided
again that a market rent is paid. But there’s nothing to stop you
giving your children the money to pay that rent, which is used to pay
off the mortgage inside the pension
• Residential property overseas. Specialist advice will be needed
to ensure that the tax advantages attaching to the SIPP are not negated
by any taxes levied by the country in which the property is located
Buy your own house
In fact, your Sipp can even buy a property owned by you or your immediate
family and place it inside the pension. The market price must be paid
for the property.
• The advantage of this is:
You free up cash previously tied up in the property but still get to keep using it – as long as you pay a market rent. Note that there may be capital gains tax implications on the sale of a second property to the Sipp
Buy a BIG property
You can form syndicates to jointly buy properties.
Groups of SIPP holders can pool together their assets to jointly purchase
a property. A legal agreement would be drawn up setting out the proportion
of the property owned by each of the individual SIPPs.
What are the benefits of a Sipp?
Here’s the beauty of a Sipp: you get full income tax relief on the
purchase price of the property.
• For higher rate taxpayers that would mean using only £60,000
to buy a property worth £100,000
• For standard rate taxpayers this would mean a saving of 22% instead
of 40%
In addition, if this is a buy-to-let any rental income from the property
will collect tax-free in the pension fund. Any proceeds from selling the
property will also be exempt from capital gains tax when sold by the fund.
Potential downsides
• If you buy your own home and you then live in it, you will have
to pay a fair market rent remains in the pension fund
• Any rent will stay in the pension fund free of tax. However, you
will not be able to access this money until you take your pension. Note
that from 2010 the minimum age for taking a pension will be raised from
50 to 55
• If you buy a property abroad, you might have to pay local taxes
on the sale
• If you were to only have ONE main residential property and you
buy it to stuff into your SIPP, bear in mind that you will need to keep
paying “rent” into the SIPP as long as you keep living in
it. Thereafter, at some stage, no later than 75 (unless the rules change
in the future), that property may need to be sold to provide you with
an annuity. At which point you may be homeless. This is why a Sipp works
best with second homes or buy-to-lets
How to find the money to buy a home
The biggest drawback to the changes in April next year is that –
as I mentioned earlier - from April 2006 the maximum loan that can be
obtained by a SIPP to buy property (whether residential or commercial)
will be cut to 50% of the fund value.
The 50% figure is based on the value of all the assets held in the fund,
not just the property. So, for higher rate taxpayers, a loan of £50,000
would help fund the purchase of a property worth £150,000.
However – and this is where things get slightly complicated –
from April 2006 you will also be allowed to put a lot more money into
their pension funds than at present.
At present, the amount you pay is based on your age and your earnings.
For example between the ages of 56 and 60, you can put in up to 35% of
your earnings into a pension and 40% from 61 onwards.
But from April next year, the amount you can stick in will be equal to
100% of your net relevant earnings the previous year, subject to a maximum
of £215,000 a year, rising annually in line with inflation.
So you can build up money in a SIPP more quickly, allowing you to reach
that tipping point where the amount you have in the pension then allows
you to borrow much more than before.
Plus, even under the old rules, you still have two more years’ worth
of contributions to place into a personal pension – both this tax
year and last year’s, using what is known as “carry-back”.
Carry-back is basically a system that allows you to use your previous
year’s contribution allowance in the current year, as long as you
do so before January 31st.
So, in practice, you have until the end of January next year to make payments
into your pension in respect of the 2004-2005 tax year just gone.