Many times we hear “my property is my pension”, where people are talking about their home or buy-to-let portfolio, but combining property and pensions can achieve greater tax efficiency.
First, the money used to buy the property will have received tax relief on it; this makes saving for the property a lot easier, especially if employer contributions are involved. The employer contributions will have received corporation tax relief, which can be a real benefit for owner-managed firms.
On the purchase of the property the usual taxes apply, such as stamp duty land tax and VAT, although in many cases the VAT can be reclaimed by the pension scheme.
The real benefit comes when the rental money is received into the pension scheme, as it is tax free rather than subject to income tax if it has been received personally.
These funds can be used to pay off a mortgage if there is one, or to build up additional funds for retirement and invested accordingly. If and when the property is sold, there will be no capital gains tax to pay on the increase in value.
All this makes for very efficient investing, but as it is a pension there are other issues to consider.
Only commercial property is allowable in a pension without incurring tax charges. Commercial, in this context, isn’t quite the same as some people might think.
Some buildings such as a bed and breakfast or a holiday let, which are technically used as a business, are not classed as commercial when thinking about pension schemes. A good rule of thumb is if you can live in it, it is residential.
As with most pensions legislation there are exceptions to the rule. Take a pub, for example: most of these will have a flat above for the manager, so you would think it would be classed as residential. This isn’t the case where the flat is occupied by the manager of the pub who isn’t connected to the scheme member and has to occupy it for their job. This sort of exception applies in many cases.
The impact of the tapered annual allowance for high earners, and the money purchase annual allowance (MPAA) for those who have flexibly accessed their pensions, means pension savings are significantly restricted for many. This may impede the amount that can be saved to purchase the property, but contributions may not be necessary once the property is in the scheme.
Rental income from properties held within a pension is treated as growth in the fund, so won’t be impacted either by the taper or the MPAA. This can be a great way to continue to build your pension or create an income stream when you are restricted on what you can pay in each year.
There are often concerns about the liquidity of property investments when a member wants to retire, but if managed well this issue can be mitigated. There is always the option to sell the property at the point of retirement, but this could be at a bad time in the market, or it may be a property linked to a business the member still retains into retirement.
The pension freedoms enacted in 2015 offer greater flexibility on the timing and amount of income that can be withdrawn from a pension. Hence drawing out the rental income that has built up as and when it is needed can be done easily, and missing a few income payments will not restrict what can be accessed.
Investing in property can be a specialist area, although investing in a property locally that you understand and is occupied by your own business or one that you know can help a lot.
The main thing is finding the appropriate pension scheme in the first place that can deal with such an investment.