We are now only days away from the biggest shake up of the UK pensions industry and Self Invested Personal Pensions (SIPPs) are set to undergo a revolution. Since their introduction in 1989, the take up of SIPPs has grown significantly thanks to the flexible investment options they offer. Following ‘A-Day’ and the introduction of further permissible asset classes we can expect to see even greater interest in SIPPs.
The expectation that residential property would be one of these new asset classes led to feverish activity in this sector during 2005. Interest in buy-to-let property leapt as investors saw a way to expand the asset classes within their pension and gain significant tax breaks. However, the surprise u-turn by the Chancellor in December 2005 left many investors reeling, as it was announced that residential property could no longer be directly included in a SIPP.
The REIT option?
Despite this, there may still be ways to include residential property in your SIPP, most notably with a Real Estate Investment Trust (REIT), which the Chancellor is currently considering as an option. These collective investments will allow people to pool money in a fund and invest in various types of property without the hassle of physically buying bricks and mortar. The trust then leases the properties out – similar to a large scale buy-to-let. REITs can contain commercial property such as shopping centres and offices but may also include residential property.
It seems likely that REIT investors would not pay tax on the rental income in the same way as they do with a direct ownership. Nor will they be liable for capital gains tax when the property is sold but instead pay tax on dividend from the trust. However, putting all your eggs in one basket could prove risky especially if you opt to put your own home into a REIT, as your home could lose value, as could your shares in the REIT. Another safer option may be to open an account with returns linked to the Halifax House Price Index, such as a Guaranteed Property Bond.
Although the Chancellor removed direct investment in residential property from the SIPP equation, as it stands, commercial property can still be put into a SIPP. Following ‘A-Day’, investors will also be able to invest unquoted shares. Pending final confirmation from the Treasury, direct investment in commercial property and mixed-use property will also be permitted.
Lowering the limit
One problem that may arise with ‘A-Day’ is the proposed lowering of borrowing limits for such property purchases. At the moment the limit is 400 per cent, plus additional borrowing to cover VAT, of the value of the SIPP but this is due to fall dramatically to just 50 per cent post-‘A-Day’.
This change was planned to prevent too much of the pension going towards funding the purchase of residential property. Despite the removal of the residential property option, the limits on borrowing will still be cut to an eighth of their current levels. This has serious implications for smaller professional firms such as solicitors, accountants and architects who have used their SIPPs to purchase their business premises. The high cost of commercial property means that these new borrowing limits will make this form of investment unfeasible for most.
With this dramatic fall set to happen, teamwork amongst professional advisers is paramount. Richard Mattison, of the PAL Partnership, says: “In spite of the uncertainty ahead of ‘A-Day’, we know that the interest in pensions and the way they are used to fund mortgages and real estate purchases in general will be phenomenal. Mortgage advisers working closely with pensions experts may achieve the best result for their clients.”
Given the government’s decision on residential property there are many in the industry who feel strongly that the limit should be left at 400 per cent borrowing on commercial property to keep this form of investment within range of SIPP holders.
Positive changes
It is worth saying in closing that the majority of post-‘A-Day’ changes will be positive. With company pension schemes in decline the simplification of pension rules may be ideal, as it will allow worried investors to use SIPPs as an alternative to a company pension scheme. The transparent pricing structure of SIPPs is also appealing to many investors. SIPPs offer investors a greater degree of control over investment options. In the current economic and political climate, effective financial and pensions planning is critical to ensure you have enough put away to enjoy a comfortable retirement. The relaxation of rules around SIPPs will surely mean greater interest in them post-‘A-Day’.
Steve Urwin is head of marketing at Newcastle Building Society
