What You Need to Know about Pensions and Property
Pensions and property used to be two words that were not compatible in the same sentence. Why? Because prior to 2006, it was not allowed under UK pension law to hold any sort of commercial or residential property within a pension scheme. Those rules existed because property was considered too risky a venture to apply to pension saving. Things have changed thanks to a series of new rules put in place over the last decade.
Pension investors now have numerous ways to either hold property directly or invest in commercial or residential property indirectly. The options now available make it easier than ever to put money into what has long been considered one of the best asset classes in the UK. But investors need to be cautious. As with any other investment vehicle, property comes with its ups and downs. Every aspect of property investing has to be considered before putting any money into it.
Pensions and Property Fundamentals
The first thing to know about pensions and property is that your workplace or stakeholder pension will not be investing in it. At least it's not likely. Investing in property almost always requires establishing a SIPP or getting involved in a GSIPP offered through your employer. Most pension investors who want to invest in property set up SIPPS through pension providers willing to deal in these kinds of investments.
Within the standard SIPP, there are three options for investing in property as follows:
- Direct Ownership – Rule changes now make it possible for pension investors to own commercial property held by their SIPPs. In essence, the pension purchases commercial property and then collects a return through rental payments. The pension fund can also sell the property at any time. This is an excellent way to make an acceptable return during those cycles when property prices are rising quickly.
- Property Funds – The SIPP investor can also get involved in property by directing some of his or her investment monies into a property fund. Such property funds can either be commercial or residential in nature. This is a change, by the way. Even when investors were given the freedom to own commercial property, residential property was still off the table. The change for residential property did not occur until 2014.
- SIPP Mortgaging – Investors can use funds in their SIPPs to establish a mortgage that can then be used to purchase commercial property. As with the direct ownership model, the fund essentially becomes the owner of the property while the investor repays the loan through monthly rental payments. Rental payments are typically high enough to generate a significant return.
There is a fourth option for small investors who already own multiple buy-to-let residential properties. We will explain that in the next section of this guide. As for the three choices listed above, an individual SIPP provider may or may not deal in property investments. Any investor who wants to mix pensions and property will have to make sure his or her chosen provider is willing to participate.
Buy-to-Let Property Owners
Buy-to-let property owners whose portfolios consist of small numbers of properties may decide they want to convert from direct ownership into fund investment. There are ways to accomplish this. The easiest and most efficient way is to invest in a buy-to-let property fund willing to purchase your portfolio.
For example, consider a London-based pension saver who also owns five residential properties. That investor may decide he/she is no longer interested in being a landlord even though he/she wants to continue investing in buy-to-let. The solution is to seek out a property fund willing to acquire the portfolio. In return for the acquisition, he/she directs the money from the sale into the SIPP, followed by investing pension monies in the fund that acquired the properties.
The downside to this arrangement is that the landlord is subject to capital gains on the initial sale. The upside is that any future profits made on those properties are not subject to capital gains. One way or the other, capital gains will eventually be paid by the property owner. By selling properties to an investment fund now, those capital gains will be lower.
One other thing to consider in this regard is the annual contribution limit of £40,000 per investor. Assuming the sale of your buy-to-let properties exceeds that amount, only the first £40,000 can be contributed to your pension while still enjoying the benefits of tax relief. The remaining amount will be subject to income tax.
Buying Property Outright
It is not possible to thoroughly cover the topic of pensions and property without talking about the option of buying property outright. What do we mean by this? We mean purchasing buy-to-let property separate from your pension investments. Some people choose to do this as a means of diversifying their risks.
Every experienced investor knows that there is risk involved in any kind of investment. The lower the risk, the lower the associated returns, and vice versa. That is why investing in things such as savings accounts and bonds create such small returns. They are considerably safe in that investors stand very little chance of losing money over the course of their investments. But what if you want a higher return? You will inevitably have to assume a greater risk.
For tens of thousands in the UK, the risks associated with buy-to-let investing are manageable enough to invest separately from pension savings. They may still put money into a workplace pension or a stakeholder or SIPP plan, but they have also dedicated a certain amount of their financial resources to purchasing and developing buy-to-let property.
Is this right for you? That depends on your aversion to risk and the amount of money you have to invest. A few key points to remember when buying property outright include:
- Landlord Responsibilities – Investing in property separate from your pension automatically makes you a landlord. Certain responsibilities and obligations come with the territory, including maintaining properties and vetting renters. Being a landlord can be quite a bit of work.
- Financing – Very few small investors have enough cash lying around to purchase investment properties. Therefore, buy-to-let mortgages provide a means of acquiring properties. The mortgage interest tax relief for landlords will be going away in a few years, so that has to be considered before borrowing to invest.
- Long-Term Investment – Inexperienced property investors often fail to grasp that buy-to-let investment is a long-term deal. It is not like the relatively short term strategy of house flipping. An investor willing to make his/her money over decades of ownership will be very comfortable with buy-to-let investing; those who do not have so much time to put into property will find it less attractive.
Rule changes now make it possible to combine pensions and property together in a single investment strategy. Property might be a good option for you if your established SIPP is strong enough to make the necessary investments. And if so, both commercial and residential property has the potential of generating very healthy returns you may not get anywhere else. But never forget there is risk involved.
An experienced financial advisor who deals with both pensions and property would be the best and most qualified person to advise you in this regard. In the absence of a single advisor with the necessary experience, you might have to utilise the services of multiple advisors and their individual expertise.
Be sure you understand all the implications of investing in property before you make any decision to do so. Pensions and property can work very well together when strategically planned and properly maintained. But they can also be a combined money pit when managed poorly.
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