Don't rush into tempting Sipp property schemes

published 19 July 2006

You will soon be able to put residential property in your personal pension pot. But this is not as good an idea as it may sound.

Gordon Brown's decision to allow property-obsessed savers to put residential property into a self-invested personal pension, or Sipp (see definition below), has generated scores of articles hyping the gains to be made from using the tax break to buy second homes in Britain, or abroad, cheaply. Some analysts seem convinced these changes will bring about a huge injection of cash, which will save the property market from its current doldrums. But will it?

At the moment, pension funds can borrow up to 75% of the purchase price of a property (commercial property, as this is the only property currently permitted in a pension). But from 6 April next year (A-Day'), people will be able to invest in any type of property through their pension fund. Investors will receive full income tax relief on the purchase of a property which means a flat on the market for £200,000 would effectively only cost £120,000 for a higher-rate (40%) taxpayer. In addition, rental income will accumulate tax-free in the pension fund, and there's no capital gains tax when you re-sell the property; the only tax to be paid will be stamp duty.

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Putting property in a Sipp: don't believe the hype

It may look like a "no-brainer", says Paul Farrow in The Sunday Telegraph, but investors should be wary. First, only those with "sizeable" pension funds should even consider putting a property in it. The maximum loan that can be obtained to buy property will be 50% of the fund value: so if your pension pot is just £60,000, an extra £30,000 won't get you very far in today's property market.

And even assuming you can afford it, putting property into a Sipp is a "deeply flawed" and high-risk move, warns Antonia Senior in The Times. First, you are mercilessly exposed to any property crash when you put all your nest-eggs in one basket. And second, the hassles involved are just too big. Crucially, you will not technically own the house the pension fund is the owner and it will be governed by trustees of the Sipp provider. This means that, in reality, few primary residences will actually go into Sipps because home-owners would have to ask permission from the pension trustees every time they made alterations to their home. The trustees will be strict about how homes are maintained: they won't allow the retired builder next door to work on the property for example, but will insist on registered and costly tradesmen, says Charles Batchelor in the FT.

Putting property in a Sipp: problems for holiday homeowners

Putting a second home in your fund is even more problematic, says David Budworth in The Sunday Times. Holiday homeowners in the UK will have to pay a commercial rent to their pension funds if they or their family use the property for all or part of the year. The only way around this is to pay a benefit-in-kind tax to the Revenue this is 40% of the market rent, the proceeds going directly to the taxman, not to your pension pot. So if, for three months a year, your holiday home is used rent-free by friends and family, you will be taxed on those three months.

And if you were hoping to buy a holiday home abroad within a Sipp, think again, says Batchelor. Many companies are so wary of including foreign properties in their Sipp portfolios that they simply refuse to do it Legal & General being one example. The reason? Most European countries, including the ever-popular France and Spain, do not currently recognise the Sipp ownership structure. That makes ownership an expensive legal minefield.

Putting property in a Sipp: tax issues

Tax is also a problem, says Lorna Bourke in The Sunday Telegraph. Property assets held in a pension fund will be shielded from tax in the UK, but you will be taxed on rental returns abroad (25% in Spain), plus you may be liable for capital gains and inheritance tax. Those wanting to transfer foreign property they already own into their pension fund will almost certainly have to pay capital gains tax as they will have to sell the property and buy it back through the pension fund. As John Lawson of insurer Standard Life points out, "the tax that overseas authorities charge on rental income and capital gains could cancel out the tax relief you get upfront". The lesson: seek specialist financial advice before considering holding property within a Sipp.

What is a Sipp?

Self-invested personal pensions (Sipps) are the most flexible form of pension available. They provide access to a wide range of investments from individual shares to unit trusts, traded endowment policies and commercial property, including farmland and forestry. As of A-Day', you will also be able to invest your Sipp in residential property and collectables from art to fine wine. You will also be able to run a Sipp alongside any occupational pension scheme. Currently, the only exception to this rule is for people earning less than £30,000 a year who are not controlling directors. Sipps are particularly appealing to those wanting to make their own investment decisions. However, you can also delegate responsibility to an investment manager on an advisory or discretionary basis. Sipps are currently offered by a range of life companies, fund managers, stockbrokers and pension advisers.

For more information, see www.sipp-provider-group.org.uk