Ian Naismith, head of pensions market development at Scottish Widows , explains the refined rules governing property in pensions since changes were announced in the pre-Budget Report, and what clients holding property should do now.
The announcement in the Pre-Budget Statement - stating residential property and ‘esoteric’ investments will remain off-limits after A-Day - sent shockwaves through the industry. But what exactly are the rules now, and what can be done by those who had already made financial commitments in anticipation of A-Day?
I should first stress we are only dealing with proposals. The government will include measures in the Finance Act 2006 to reverse those in the Finance Act 2004, and we have not yet seen any drafts. However, unless there is another U-turn, we know what to expect.
Commercial property is still very much an allowable investment, but with two significant changes to the rules:
- Connected party transactions on commercial terms will be allowed in self-invested personal pensions (sipp) as well as in small self-administered schemes (ssas). This will open the way, for example, for partnerships of accountants or solicitors to sell their premises into their pension scheme.
- And there will be significant changes to the rules on scheme borrowing to fund property purchase. The maximum loan will be 50% of the value of assets (net of any existing loans). This is generally likely to be much lower than current limits, which are 75% of the value of the property for SIPP and 45% of the value of assets plus three times the ordinary annual contribution for SSAS.
Residential property is now outlawed with two exceptions:
- First, investment through pooled vehicles such as Real Estate Investment Trusts (REITs) will be allowable. So those who view residential property as a desirable asset class can still invest in it, albeit not in specific properties they choose. HM Revenue & Customs will monitor the position to ensure that it is not abused by, for example, setting up a residential property investment company where a SIPP held all the shares.
- The second exception will mirror a current concession which allows, for example, purchase of a shop that happens to have an unconnected residential flat above it. Full definitions should be included in the legislation.
Similarly, direct investment in esoteric investments will be prohibited (in the current regime these are called ‘personal chattels’). So works of art, stamps, fine wine and similar items which are bought for personal pleasure as well as for their investment potential will be outlawed. Again, it should be possible to invest indirectly in these assets through appropriate pooled investments, but not to choose them individually for your sipp.
The government plans to achieve its purpose by treating such investments as unauthorised member payments. The member will be charged 40% on the value of the prohibited asset and the scheme administrator a further 15%. In addition, if the total of unauthorised member payments reaches 25% of the value of the member’s rights, a further 15% tax is payable by the member, taking the total charge up to 70%. And if the value of prohibited assets were to reach 25% of the total scheme assets, it could be deregistered with a tax charge of 40% on scheme assets. So, investment in residential property and esoteric assets is not impossible, but will result in a huge financial hit making it completely unviable.
But what to do about clients who have already made investments or financial commitments, in anticipation of the new regime? There are transitional protections, but they are unlikely to help much in most situations.
Certain assets associated with residential property are currently allowed in pension schemes. These include ground rents, feu duties and property attached to a job for someone unconnected to a pension scheme. As long as these are not enhanced or developed after A-Day, the investment will be protected.
Some schemes have also bought property not currently fit for residential use, with plans to develop it later – what are known as ‘offplan purchases’. These will be protected if bought before 6 December 2005, as long as they do not become residential properties in the future. In practice, this may well mean that they are best sold as soon as possible, but it will be a buyer’s market for such property so the purchase price may not be recovered.
Similarly, indirect investment in property which is allowed under the current regime and residential property investment by ssas schemes before 1991 will be protected, but in both cases only if they are not enhanced after A-Day. There are also a few other minor protected classes.
The most common situation, though, appears to be people:
- who have already bought a property and were planning to put it into their pension after A-Day;
- who have committed to buying a property after A-Day, or
- who have bought an option to purchase a property after A-Day.
They have no protection, and could lose out heavily.
While many people would agree with Gordon Brown that residential property and esoteric assets are not generally suitable for direct pension scheme investment, it is very unfortunate the decision was made so late in the day. I am sure strong complaints, and perhaps also court cases, will rumble on for some time to come.
The Government has published a technical note on the changes, available at http://www.hmrc.gov.uk/pbr2005/pensions-simplification.pdf.IFAonline
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