Dear Delia One of my clients is an experienced landlord with nine properties worth 1.27m. As he is in his 40s and concerned about retirement he has asked me if he should put some of these properties into a self-invested personal pension after A-Day. He is also interested in buying more properties and would like to know if he should buy these through a SIPP. What would you recommend?
Delia says: Using a SIPP for further properties he buys is an option worth considering. Lee Grandin of Landlord Mortgages and John Heron of Paragon Mortgages offer their views.
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Lee Grandin is managing director of Landlord Mortgages
Looking at this from the perspective of a professional landlord only, I don’t believe it would be a good idea for your client to include all or a significant part of his portfolio in a SIPP wrapper. In order to place his properties into this type of retirement savings vehicle he would need to sell the property to the managing trustee. If as I suspect he has built his portfolio up over a number of years, this is likely to land him with a significant Capital Gains Tax bill.
He will need to have sufficient existing funds within the SIPP to buy the property. You can’t simply sell your property and quickly pop the proceeds into your SIPP to repurchase it. If your client has the majority of his assets in his property portfolio, he may need to sell some of his other properties – and face CGT liability – in order to do this.
But a SIPP can use gearing to buy a property and so your client may not need to heavily deplete his portfolio. The fund can borrow 50% of its value in order to buy a property, so to buy a 225,000 flat you will need to have 150,000 in your fund.
Another point that should be considered is that after A-Day on April 6 2006, when residential property can be included in a SIPP, consumers will only be allowed to have a total retirement pot of 1.5m before they become liable for tax. If your client includes lots of his properties in a SIPP, this will mean his portfolio is heavily reliant on fluctuations in the property market. This is potentially a dangerous decision to make.
Your client needs to realise that while including property within a SIPP has several useful tax advantages, trying to do this with existing property investments may bring a huge CGT bill, overexposure to one asset class and huge financial hassles.
If your client is set on including residential property in a SIPP he should do this with the next property he buys after A-Day. He will still need to have sufficient funds in his SIPP, which may require a property sale, but this is likely to be the simplest option.
But prior to any of these changes, your client needs to thoroughly review all of his finances. This is not simply a retirement issue but encompasses Inheritance Tax issues too, especially if he has children or relations he would like to provide for in future.
John Heron is group director of mortgages at Paragon Mortgages
Your client has already done the first thing we recommend in these cases and spoken to a financial adviser, so he is already one step ahead of many other people.
If he intends to put property in a pension arrangement, he will need to be sure he has the capacity within his normal limits to fund a pension scheme in order for it to buy the property. He will also want to be sure that the mix of assets in his schemes is well balanced.
Once he has looked at these points, if he still wishes to proceed he must consider several things. First, he cannot complete on a transaction before A-Day as this is the point at which the new pension rules become effective.
Second, when considering whether he should move existing properties into a scheme or buy new ones, the overriding concern should be about the legal and administrative structure of a pension investment.
Third, the InlandRevenue requires pension funds to be managed by a properly authorised trustee. A trust has to be set up for the pension beneficiary and the trust holds and owns the property.
If your client already owns the property in their name it will have to be sold to the trust. This is a so-called arm’s length full value sale, with any profit being subject to Capital Gains Tax. As this is the case, the beneficiary will have to consider the potential implications of incurring CGT at this time.
A simpler route would be to buy additional property through the pension scheme rather than in the beneficiary’s name. Once in the scheme, property income is free of tax as are capital gains on the property as long asthe income or profits remain in the scheme.
The beneficiary may want to ask the trust to take out a mortgage thereby utilising gearing to maximise property income and profits.
The trust can borrow up to 50% of the value of the fund. In simple terms, this means if a beneficiary contributes 100,000 to a scheme, that scheme can borrow another 50,000 to assist in the purchase of property.
The trust needs to be aware that it has the full obligations for mortgage payments and needs therefore to ensure that there are sufficient cash reserves in the scheme to meet all mortgage payments and property maintenance requirements.
In the event of a property becoming void, mortgage payments still have to be made and it may be necessary in extreme situations for other pension assets to be sold to meet liabilities or for the property itself to be sold.