Guardian: Self-invested personal pensions - new real estate investment rules

Cover story
Is this the answer to your problems?

Self-invested personal pensions - or Sipps - will mean huge gains for
some. Rupert Jones reveals who wins ... and who doesn't

Saturday October 8, 2005
The Guardian

It's become the hot topic of conversation at middle-class dinner
parties and in the corridors of investment banks and law firms. In a
few months' time, a new tax break will allow thousands of well-paid
professionals and other wealthy individuals to buy residential
property, at just a fraction of its real cost, using their pensions.
>From next April, they will be able to use their retirement pots to
purchase buy-to-let properties and holiday homes tax-free - in other
words, financed in part by you and me. That will give them a massive
advantage over first-time buyers, who are likely to find it even harder
getting on to the first rung of the property ladder.

Commentators have talked breathlessly about how the well-off will enjoy
an effective 40% discount on a second home. However, for many people it
will actually be even better than that. As we show here, the new rules
mean a high earner will effectively be able to shell out just =A3114,000
of his or her own cash to buy a =A3250,000 house. And if they then rent
the house out, all the rental income is tax-free and invested back into
the pension fund, further boosting their retirement nest-egg.

The shake-up involves a type of pension plan called a self-invested
personal pension (Sipp). From April 6, you will be able to contribute
100% of your annual salary (up to a maximum of =A3215,000) into a Sipp
and, for the first time, use it to buy residential property and/or
exotic items such as fine wine, stamps and gold. Investors will also be
able to borrow up to 50% of the value of the pension fund in order to
increase their buying power.

It's best explained by using an example. It's a complex business so we
sought the help of John Lawson, pensions guru at Standard Life, which
reckons it is probably the biggest Sipp provider at the moment.

Our fictional City trader, Giles Heathcot-Onslow, earns =A370,000 a year
and expects to pick up a =A3100,000 bonus next year. Now, Giles can pay
20% of his earnings into a Sipp. That's =A314,000 - but because of basic
and higher rate tax relief, a contribution of this size actually only
costs him =A38,400. Giles can also make use of the "carry back" system,
which means he can pay in now and have it treated as if it were paid in
the previous tax year. So that's another =A314,000.

Come April, Giles can contribute as much as he likes of his salary, so
he puts in =A370,000 (but this only costs him =A348,660). Mr Lawson
explains that "salary" as defined here includes everything that's
taxable - even the cash value of perks such as company cars.

In April 2007, Giles sticks another =A370,000 in his pension (costing
him =A348,660). He now has =A3168,000 in there. Because he can borrow up
to 50% of the value of his fund in order to buy a property, he can now
buy a house to the value of =A3252,000. However, factoring in the
purchase costs, perhaps =A3240,000 would be more realistic.

Giles decides to rent the house out. There will be a letting agency fee
slicing around 15% off the rental income, but the rest goes into the
pension. There will be fees, though - a set-up charge of around =A3500
and an annual fee of maybe the same amount.

So, can those people who already own one or more buy-to-let properties
put them into a Sipp from April? Yes, but the benefits aren't as great
as they are for post-April purchases, says UCB Home Loans. Most people
who do this will probably use their pension fund to buy the property
from themselves, though they've got to have quite a lot in their pot to
do this. When a property is moved into a Sipp, it becomes owned by the
fund and capital gains tax will need to be paid on any profit made on
the sale. But if, say, you only bought the property a year ago, the
gain may come within your =A38,500 annual CGT allowance. The pension
will be liable for stamp duty on the purchase.

You can put a holiday home into a Sipp, but if it's not in this
country, it could be a problem. Many countries, including Spain, don't
recognise trusts as a legal structure (Sipps are trust-based
contracts), so you might have to set up a limited company there that
owned the property, says Mr Lawson.