Whilst it remains true that there is no such thing as a free lunch it is possible, with careful planning and judicious investing, to get the taxman to go Dutch with you – or at least to pay for dessert!
How?
The use of a personal pension plan – a Self-Invested Pension Plan or SIPP being the most obvious one – to make property acquisitions allows you to buy property anywhere in the world with the taxman’s blessing and a contribution from him. But you do need to follow the rules carefully otherwise the property may be deemed to be taxable and you will lose the benefits you had planned on. It is likely you will need a specialist SIPP fund manager with expertise in property as well to ensure you don’t trip up and scupper all those well-laid plans.
To help you identify whether this scheme is likely to be of interest it is worth recapping some of the basics first.
Why do the tax authorities assist with pension funding?
To quote from Her Majesty’s Revenue and Customs (HMRC) website:
“The government encourages you to save for your retirement by giving you tax relief on pension contributions. Tax relief reduces your tax bill or increases your pension fund.”
Or, put another way, if we let you have the money to save now there’s a greater chance you won’t need to ask us to pay for your retirement later. So, to help you save for your retirement the taxman effectively allows you to contribute to a range of pension funds from your untaxed earnings rather than expecting you to save only out of taxed income.
The rules for tax refunds apply pretty much equally to all types of pension funds including employer-run funds and personal pension plans, of which a SIPP is just one type.
What is a SIPP?
Again, to quote HMRC:
“A SIPP is a type of personal pension scheme. The SIPP itself is a pension “wrapper” that holds investments until retirement and the investor starts to draw a pension income. Most SIPPs allow investment in a range of assets including commercial property. SIPPs are designed for people who want to manage their own fund by dealing with, and switching, their investments when they choose. They may have higher charges than other personal pensions or stakeholder pensions. As with any pension fund, the investor cannot take money from the fund until age 50 (rising to age 55 by 2010).”
In other words, a SIPP is just another type of pension but one where you control what the money is invested into. But, as it says above, it is not a “liquid” investment as you cannot access the money in your pension plan until you reach retirement age.
All pension funds will be managed by trustees whose responsibilities are clearly set out in law and include the need to make shrewd decisions. You may well be one of the trustees but that will not give you rights over the underlying assets in the fund as if they were your own – your overriding duty is to ensure all your decisions contribute to the maximisation of the pension the beneficiary of the fund (again, probably you) will eventually be able to draw. The trustees will need to review the quality and returns from all assets in the fund on a regular basis to make sure they are suitable for achieving this objective.
They will also need to manage the assets appropriately – if property is held within the fund it will need to be maintained and repaired by reputable workmen not the chap next door who doubles as the occasional handyman!
So how does the taxman help?
In essence the taxman gives you back the tax you have paid on the funds you invest into a pension fund. Initially, you receive back, through the fund itself, 20% so that for every 80p you contribute to your pension the fund receives £1. If you pay tax at a higher rate you then simply declare these contributions on your tax return (or write to the tax office concerned if you don’t complete a return) and the additional tax you have paid will be refunded or offset against any other tax liabilities you have.
Not bad.
This actually means you can nearly double your money if you are a higher-rate tax payer. And this is how:
Say you invest £8,000 into your fund in any given year. Your fund now has £10,000 in it due to the tax you automatically receive credited to the fund.
When you complete your tax return you also claim back a further £2,000 being the balance of the 40% you have been charged on the total of £10,000 now in your pension pot. So that £10,000 has only cost you £6,000. It seems rude not to take this largesse from the Exchequer, doesn’t it?
But it doesn’t stop there because your pension fund also remains tax free on an ongoing basis – all income from your investments and any capital gains made by the fund remain free of tax. What’s more, your pension fund is permitted to borrow money too in much the same way as you can. Provided it keeps within the rules (generally it cannot borrow more than 75% of the value of the property) it can raise a mortgage and repay it from either the income the property generates or from your future contributions (again tax-free of course).
So imagine now that your £10,000 pension pot is used to buy a property with a mortgage giving you an asset worth £40,000. In 10 years time the mortgage has been repaid and the property is worth, say, £100,000 – your pension fund has made a capital gain of £60,000 tax free and the fund value of £100,000 has cost you only £6,000.
Does this mean I can buy lots of nice houses on a tax-free basis?
The answer to this question is yes….but. In other words, there are rules that must govern what sort of property the fund buys to avoid losing its tax-free status and also how that property is treated going forward.
In short, pension funds are only allowed to invest in “commercial” property which has generally meant property let on a long-term basis such as offices, warehouses, retail premises and the like. After all, the taxman wants to help build your pension pot, not provide you with an inexpensive way to buy a nice pad near the beach.
However, increasingly overseas property promoters – developers and their partners – are creating mechanisms to facilitate the purchase of such properties through SIPPs or similar pension plans. They cannot circumvent the basic rules but for those of us looking to benefit from better property markets elsewhere to provide a nest-egg for the future these developments make perfect sense.
The rules to be aware of
Using a SIPP to buy property abroad will not be for everyone so make sure you know the main rules before you spend (waste?) too much time researching this option.
• You cannot use the property yourself. If you’re looking for a holiday home or even somewhere permanent to live you should not consider buying it through a pension fund – you will lose the tax benefits and not actually own the property yourself;
• If the property is residential rather than commercial there are quite complex rules governing how the property is to be held since the pension fund cannot own it directly 100%;
• You will not be able to enjoy any of the income from the property or the proceeds of its sale except by way of pension drawings when you reach the appropriate age.
The terms used by HMRC are quite difficult to grasp and the process and monitoring can be quite difficult but as long as the conditions are met it is perfectly feasible to benefit from the advantages owning residential property can confer.
There is one clear benefit of including residential property in a portfolio held by a pension fund as frequently in the past the increases in value enjoyed in the residential market have outstripped those in commercial markets. And just because you have purchased through a fund and cannot enjoy the property yourself does not mean it cannot subsequently be sold to someone who would own it privately and use it as a residence.
Where to find appropriate properties
It is fair to say that finding SIPP-ready properties in the residential markets, here and abroad, is far from simple at the moment as developers are only just beginning to cotton on to the possibilities. But one great new investment being launched on Margarita Island has already passed through the necessary hoops and is SIPP-ready.
This beach & spa resort comprises 1,244 apartments and duplexes spread over 14 floors, overlooking the stunning Caracola Beach. Populated across three blocks, the apartments vary in size from 57.50 to 125 square metres, nearly all with their own sea view.
Construction will be to the highest of standards in accordance with the most stringent of building regulations. Each apartment will have a fully fitted kitchen (including white goods) as well as hot and cold pumped air conditioning. All bathrooms will be fitted out with Roca or equivalent quality appliances. The development will provide plenty of semi-covered parking spaces to accommodate the resident or more adventurous tourist.
The project is designed to be very eco-sensitive with the use of solar panels to assist with the supply of electricity. Two layers of bricks with foam insulation, combined with double glazed windows make for a very thermally efficient apartment.
The whole resort will be managed by a top quality hotel group and the US tourist market is expected to be its main source of revenue. This has been a key element in obtaining SIPP-ready status for the units.
This is just one of many we expect to see coming onto the market so if you want to be first in line for these (and we are planning to set up SIPP funds to take advantage of the market) give us a call or drop an email over – we’ll keep you up to date on the products coming on stream and the SIPP funds available to you.
