Mary Stewart highlights the opportunities available to people hoping to use protected rights money to purchase property
It is perhaps ironic that the start of wider investment for an estimated £100 billion in protected rights monies has happened in the middle of the one of the worst financial crises since the Great Crash of 1929.
A year or two ago, holders of self-invested personal pensions (SIPPs) could have moved any protected rights provision built up in insured funds into a wide range of thriving asset classes or investment vehicles. However, the reality now for many will be to double-check the security of a deposit account provider, or find another more prudent home for their windfall.
For many SIPP investors a sensible course of action will be to use their incoming protected rights fund to reduce any outstanding mortgage for a commercial property held by the SIPP. There are a number of reasons why this strategy makes sense.
In some cases, individuals will have taken out a mortgage within their SIPP with the express intention of paying back part or all of it with protected rights funds once they were enabled to do so by the legislation. The rules allowing protected rights to be held within all SIPPs came into effect on 1st October 2008.
Time to invest
In other cases, individuals will be looking at the recent financial carnage and wondering if this is a good time to invest in assets with a high risk/reward profile. For some brave investors, the current conditions may represent a buying opportunity, while for others, this is still a time to hold back. In this case, paying down a mortgage delivers an effectively risk-free return equal to the interest rate being charged on the borrowing.
It could also be the case that a mortgage taken out some time ago is due for review and if this is so, the terms may become less attractive to the borrower. SIPP investors may also like the idea of removing any gearing from their SIPP at the present time. By paying off a mortgage, the SIPP holder will gain more flexibility and freedom over any rental income received from the tenants of the property, which will also be a positive in the current climate.
Given that protected rights allocations to individuals could easily top £50,000 - even more in a small number of cases - the ability to place this sum within a SIPP could make the difference in enabling a SIPP investor to purchase a property. This is particularly the case since the rules on how much a SIPP can borrow to fund a property purchase were revised at A-Day.
Since the A-Day changes, the maximum that can be borrowed by a SIPP is 50% of net scheme value and this must cover all the costs associated with the purchase. This means there can be no bridging loans for VAT costs, as was the case pre-A-Day. An existing debt will also reduce the amount that can be borrowed.
For advisers, it is worth bearing in mind that the credit crunch could make the purchase of business premises through a SIPP a pragmatic way to inject cash into a business. In this scenario, banks may be tightening their lending criteria and reducing credit to a small, but reasonably profitable, enterprise.
If this is the case, a business that owns premises can sell them to a SIPP held by the business owner at the market value. This gives the business a cash lump sum and in future, rents paid over to the SIPP are free from income tax. The tax efficiency of this, combined with the extra funding without strings, is likely to make it an appealing proposition for many SIPP holders involved in the small business sector.
It is difficult to generalise about SIPP investors with substantial protected rights funds, but they will normally be older individuals who have been contracted out for some time. While they will have a background of being employed, they may well have moved to self-employed status and have built up their own business interests. This would tie in nicely with the use of protected rights in the purchase of their own business premises.
One concern with the use of protected rights for a mortgage repayment, or to facilitate a property purchase, could centre on the state of the property market. However, commercial property is a different beast to residential property. A wide variety of commercial properties can be held within a SIPP, from business premises, to properties as diverse as museums, petrol stations, farmland, commercial forestry, nursing homes, hospitals and football stadiums. Specialist properties will have a different dynamic in terms of demand and supply to other parts of the property market, so they could still represent an attractive investment.
In addition, most investors are naturally more comfortable with a tangible asset such as property, even when markets are rocky, than they are with share investments. As investors are likely to be scared off equity investing at present, an adviser will probably get a more sympathetic hearing for using protected rights for a property deal, than they would for moving money into stock market based investments.
For financial advisers, the next few months are likely to be a time of reassuring clients, helping them buttress their portfolios against further shocks and reviewing asset allocations in the light of recent events.
Advising SIPP investors on the options for their protected rights will be part of this process and for many reducing the borrowing on any property held by the SIPP will be a sound and safe plan.
As a final point, financial advisers should ensure that their SIPP provider can deal with the full range of commercial property and is well-versed in dealing with property transactions. Service is a key element of the provider offer to SIPP investors and advisers, and advisers should satisfy themselves that their chosen SIPP provider can make any property or mortgage transactions as smooth and painless as possible.
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