Sunday, September 18, 2005

Sipp investment

MUCH hype has surrounded the ability to hold residential property in pensions come next year. But will it be all it has been cracked up to be?

Under widespread changes to UK pension regulations on 6 April, known as A-Day, the government will relax restrictions on the types of assets investors can hold in a self-invested personal pension (SIPP). You will now be able to hold in a SIPP residential property, as well as direct private equity investment, unquoted hedge funds, classic cars, fine wine and art.


The in-coming changes have aroused the interest of scores of investors - many of whom were badly burnt in the 2000-3 bear market, but have seen the value of their homes soar.

"With the 'pension timebomb' issue looming large in many people's mind, the SIPP is becoming an increasingly attractive alternative to the personal pension," says Alan Fergusson, director of employee benefits at Kudos in Aberdeen. "Changes to regulations will make the SIPP an even more flexible solution."

While traditional personal pensions or stakeholder plans often allow retirement savers to invest only in providers' own funds or a limited set of funds run by other managers, SIPPs are pension wrappers within which you can hold a wide range of investments - from individual UK shares, unit trusts and investment trusts to multi-manager funds, unit-linked funds and commercial property.

The expansion of that range will give savers greater choice. As well as the increased flexibility afforded by SIPPs, contributions are tax-free. SIPP investments grow free of capital gains and income tax and there can be significant inheritance tax benefits too.

Angus Kerr, a fund manager at Aberdeen Asset Management, believes many people should be considering starting a SIPP ahead of A-Day, when you will be able to pay 100 per cent of earnings into your pension (subject to a maximum £215,000) and there will be no need to buy an annuity at 75.

"With the introduction of the pensions cap in the late eighties, many people, particularly those who had moved jobs more than once, found that they were severely under-provided for," says Kerr.

"This, combined with the poor performance of with-profit funds culminating in the Equitable Life debacle, led to an increased interest in SIPPs.

"In preparation for SIPP A-Day, those with defined contribution schemes in several pots should seriously consider sweeping them into a SIPP, where they can control the provision entitlement."

Setting up a SIPP is not difficult. The tricky bit is deciding how to invest the SIPP plan. So, what of holding residential property, either in the UK or overseas, in your pension?

First, let's look at putting your own home in your fund - a possibility come A-Day when a rule on transacting with "connected parties" disappears.

Transferring your principal private residence into your SIPP pension fund will, for many, be a bad move, warns Darrel Poletyllo, author of The Scotman's pensions simplification guide.

Owning your main home directly entitles you to 100 per cent of any gain upon sale free of tax. But, put it in your pension scheme, and the ownership transfers to the scheme trustees. Now, you will only be able to take 25 per cent of your SIPP fund tax-free, with the balance as taxed income.

However, with an incredibly favourable tax environment - especially for higher-rate tax-payers - the changes might prove a boon for buy-to-let investors and those with second homes.

As property purchases will be set against income tax, a 40 per cent taxpayer will effectively only pay £120,000 for a £200,000 property. Those who pay basic-rate tax at 22 per cent will pay £156,000. If the property is let, the rental income will be free of income tax. When sold, profits will be free of capital gains tax (CGT).

Factor in an annual rental yield of 4.2 per cent and capital growth of 3 per cent per year over ten years, and the total gain for SIPP holding a £200,000 property through a pension fund is a huge 127 per cent, against just 47 per cent for the same property held directly.

Says John Lawson, marketing technical manager at Standard Life: "For buy-to-let investors saving up for their retirement, it's really a no-brainer."

But, anyone interested in transferring a property they already own will have to do so at full market value - and will be liable to CGT.

Aware of this, savvy pension savers have stockpiled an estimated £11 billion, ready to invest into the buy-to-let market after 6 April. Nationwide subsidiary UCB Home Loans believes the new SIPP rules will boost the market by 15 per cent, while the Property Investor Show anticipates more than £6.5bn will go into properties held in SIPP pensions in the year after A-Day.

Some 65 per cent of buy-to-let mortgage brokers believe the changes will lead to an average 11 per cent uplift in business, according to Mortgage Trust's September forecast. But a hesitant 35.3 per cent think the potential effect on the market has been over-exaggerated.

As pension trustees will only be able to borrow 50 per cent of the value of a scheme's assets to buy a property - instead of 75 per cent of the property value at present - the majority of investors are unlikely to be able to participate.

To buy a £400,000 property, a scheme could borrow up to £300,000 on 5 April, meaning the fund size need only be £100,000. But, just one day later, the same fund would only be able to borrow £50,000, making the most expensive property that can be bought worth just £150,000.

"As usual, what the Treasury gives with one hand, it pickpockets with the other," says Matthew Robbins, an adviser at Haines Watts in Edinburgh. Then, there are concerns that the buy-to-let market has become saturated.

According to the latest figures from the Council of Mortgage Lenders, the market is slowing. Will you be able to rent the property out? Will your fund be able to cope with void periods, still meeting mortgage payments and other expenses?

And you should avoid having an over-concentration in bricks and mortar. With a well-diversified SIPP portfolio usually having around 20 per cent or less in property, is your pension fund large enough?

What about the lack of liquidity? If most of your scheme assets are tied up in property, will be able to secure the required income without having to sell up? And are you able to forgo the rental income and potential capital gains in the long-term? Until you are 55? Even then, you will only be able to take 25 per cent of your fund in tax-free cash.

The message is clear: do your homework before jumping on this SIPP bandwagon.

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