Self invested personal pensions (SIPPs) explained
A self invested personal pension (SIPP) is exactly the same as a ‘normal’ personal pension except that it offers a wider range of investment choices not typically found in an insurance company plan (i.e. the self invested bit). The maximum contribution limits, retirement and death benefits for a SIPP are the same as with a ‘normal’ personal pension.
The introduction of SIPPs allowed investments into a wide range of assets including:
– Stocks and shares listed on a recognised exchange
– Futures and options traded on recognised futures exchange
– Authorised UK unit trusts and OEICs and other UCITS funds
– Unauthorised unit trusts that do not invest in residential property
– Unlisted shares
– Investment trusts subject to FSA regulation
– Unitised insurance funds from EU insurers
– Deposits and deposit interests
– Commercial property (including hotel rooms)
– Ground rents (as long as they do not contain any element of residential property)
– Traded endowments policies
– Derivatives products such as a contract for difference (CFD)
– Structured investment products
– Gold bullion
As well as these investment options the other significant benefit available to SIPPs is the ability to borrow to fund investment purchases. In practice, as lenders will want a tangible asset to secure any borrowing against this is virtually restricted to commercial property purchases.
Commercial property purchase
The maximum borrowing rules have changed over the years and now the maximum borrowing is 50% of the net asset value of the SIPP. The value of the building being bought is irrelevant for calculating maximum borrowing (although it remains an important issue for the lender of course).
The most common property purchase we arrange via a SIPP is where the client wishes to buy the property from which they operate their business. In most cases the property is owned either personally or via their company, however it could also be bought from an unconnected third party.
The following example assumes the client owns the property personally and operates his limited company from the same property which has been independently valued at £300,000 with rental value of £24,000. All property valuations for SIPP purchases have to be current and provided by a qualified independent chartered surveyor.
As well as the property value there are other costs you would expect with a property transaction. The following are provided as a rough guide only– cost will vary from case to case:
Purchase price £300,000 not subject to VAT
Stamp Duty £ 9,000
Valuation Fee £ 882 (incl. VAT)
Solicitors Fees £ 1,469 (incl. VAT)
Search Fees / Disbursements £ 950
Provider fees £ 1,810 (incl. VAT)
Our FP fees £ 3,525 (incl. VAT)
You will note that in this example I have assumed that the property is not subject to VAT on the sale, however if it was then the SIPP would have to fund an additional 20 per cent.
Should VAT be payable then the SIPP can reclaim this when the first VAT return is completed, as pension arrangements are exempt from VAT. The reclaimed VAT would be paid back to the SIPP only and not to the client or his company.
Irrespective of whether the property purchase is VATable or not, we would usually register the scheme for VAT so that any VAT on the rent and fees could be reclaimed by the SIPP.
I have also assumed that in this case the client has £62,000 accumulated in previous pension arrangements that are available(and it is suitable) to transfer into a SIPP, the client’s company has net profits of £250,000 and sufficient cash for a pension contribution. (It should be noted that it is not always the case that transferring existing plans to a SIPP would be the best course of action).
With the total purchase cost of £317,636 the property would be funded as follows:
Estimated Funding Required
Existing Pension Fund £ 62,000
Employer Gross Pension Contribution £150,000
Bank Borrowing £106,000
The employer contribution assumes that the client has sufficient unused annual allowance (including carry forward) to enable the employer contribution to be paid.
Once the property purchase transaction has been completed then the main benefits would be:
1. The company will have offset the pension contribution as a business expense against profit saving £30,000 corporation tax (at 20 per cent).
2. The client having sold the property will have received £300,000 into his personal account – this will of course be subject to CGT on any gain made.
3. The client’s net retirement fund will have increased from £50,000 (the old arrangement) to £194,000 (i.e. property value less loan / set up costs).
4. The client’s company will pay rent of £24,000 pa to the SIPP for the use of the property, which again is a business expense saving £4,800 corporation tax each year.
5. The rent is used to repay the bank borrowing so that after circa 5/6 years (depending on interest on loan and ongoing SIPP charges) repays the loan.
Additional pension contributions can be paid in future years to repay the loan at a faster rate.
6. The rent would then continue to be received by the SIPP and can be invested in alternative assets.
7. When the loan has been repaid the asset value of the SIPP would be circa £300,000which could then support borrowings of £150,000 to fund another property purchase if wanted.
There are of course disadvantages with using a SIPP for property purchase, which include, among others:
1. Being an illiquid asset – it could be possible that there will not be sufficient cash available at retirement to provide benefits and the client is forced to sell during a downturn in the property market.
2. A pension invested in a single investment carries more risk than a diversified investment portfolio.
3. The company has to maintain the rental payments even if the company has a significant setback / cash flow problem.
This article merely provides a simplistic overview for a property purchase through a SIPP. If you are considering taking such a step then professional advice is essential.
If you would like some more advice on this topic, please call Dave Gleeson on 01772 821021.