This guide is for you if you are wondering if commercial property ownership might be for you. Or, if you are wondering if commercial property might be a good investment for your pension.
It sounds complicated. Why would I do this?
Just like any pension, contributions you pay into your pension get tax relief at your highest marginal rate. This means that when you can use this contribution towards buying a commercial property, it becomes the most tax-efficient way to buy commercial property.
- Your pension becomes a landlord, either to your business or to a third party. This means that 'dead' rental income goes into your pension instead of going to a landlord.
- If your business pays rent to your pension, the market rate of rent is a tax relievable trading expense (just like paying rent to any other landlord)
- There's no Capital Gains Tax when the pension sells the property, this can be worth a lot. The pension is exempt from Capital Gains Tax so any increase is tax-free.
How does it work? Am I allowed to withdraw my pension money to buy a property?
- The first thing to bear in mind is that it may be your pension, but your pension is a separate legal entity from you. Your pension will buy the property. Your pension is allowed to buy commercial property (offices, shops, industrial units), but not residential property (flats or houses).
- This means that your money stays inside your pension, although obviously your pension will need cash to buy the property. The property purchase goes through as normal, so far as the vendor is concerned.
- The pension then makes money by letting the property out and your own business can be the tenant or your pension can let the property to a different business entirely
Here's an example….
Karen has a Self-Invested Personal Pension with £300,000 in it. She has built up her pension over the past 10 years and she has it already in cash within her pension because she has been looking for an ideal property for a while.
Karen is owns a legal practice called 'Lawyers Are Great', she needs bigger premises and she hates paying rent because it feels like 'dead money' to her. She would like to buy an office but neither she, nor her practice has the £300,000 that it would cost her to buy the office she will need.
Karen finds an office for sale or rent. The purchase price is £300,000, or the annual rent is £24,000.
Karen works out that the fees for buying the property would be around £10,000 so she pays a pension contribution of £8,000 into her pension so that it will have enough to buy the property. The contribution gets tax relief added, to turn her £8,000 into the £10,000 she needs.
Now, Karen's pension has the £310,000 that it needs to buy the property.
Karen's pension puts in place a lease with Lawyers are Great. Lawyers are Great pays £24,000 per year rent, on a fully repairing 10 year lease with 3 yearly rent reviews.
Lawyers are Great keeps on paying rent, but Karen doesn't mind so much now. Because Karen's pension gets the rent.
How do I get the money out again?
- When you want to retire, you can choose what suits you best. This topic is worth a guide on its own so this is a very simplified list of the options.
- You can sell the property so that your pension is fully cash. This might suit you best if it's time to simplify your finances or to buy an annuity, or if you need as much as possible out of the pension as a lump sum.
- You can keep the property - so long as the rent comes in, your pension has the cashflow to pay out a pension to you. This might suit you if you want to stay efficient in retirement.
Do I have to throw the tenants out to retire?
Let's go back to Karen, in our example. You'll see that she doesn't have to throw out the tenants, here's how:
Seven years later, Karen is ready for retirement. She sells her practice and her pension keeps getting the rent from the new owner until the end of the lease.
Her pension is now valued at just over £570,000 and £230,000 of that is accumulated rent, in cash, so she can begin drawing her pension immediately. There is enough cash in the pension to pay out her Pension Commencement Lump Sum of about £142,000. There is also enough cash to pay her a pension for a while, but not forever.
Three years later, at the end of the 10 year lease, Karen's pension negotiates a new lease, this time the rent is £27,000 per year on a five year lease. It suits Karen better to have a shorter commitment now. The rent will allow her to continue drawing more pension for a few more years (but not forever).
At the end of the five year lease, Karen's pension sells the property for, say, £600,000. At this stage, if she wants to simplify her finances and get some security, Karen can swap the lump sum for a pension annuity.
I found a great property with a shop underneath and a flat on top. Can my Self-Invested Personal Pension buy it?
- In our experience, your Self-Invested Personal Pension won't want your SIPP to acquire this type of property because the property has to be predominantly commercial. If it is a fairly small property, with a flat above, the floor space of the flat is probably too big as a fraction of the whole floor space.
- If you find yourself in this position, some individual advice may be worthwhile.
- Every case is different of course, but those are the rules as we find them. If you find a property like that, it may be possible to divide the property into two separate titles. Your Self-Invested Personal Pension would be allowed to purchase the ground floor commercial, retail or office premises.
- You would need to buy the upstairs residential accommodation separately. There are other potential issues with that strategy, obviously the conveyancing cost will be higher and the vendors may not be very patient as you have to go through more steps.
Who finds the property?
It is up to you to find a suitable property. The pension provider will not normally bear any responsibility for the suitability of one property over another. For example, if you are weighing up to different industrial premises, the decision of which one to buy will rest with you.
Can I buy any property I choose?
You can buy any suitable property. Your pension provider could refuse to partake in a purchase, if it feels that the purchase is unsuitable as a pension asset. This doesn't happen very often, because you and your Self-Invested Personal Pension provider will both want the best for your pension assets.
These are the two most likely reasons why they might say 'no' to a specific property:
- To stop you from making an 'unauthorised transaction', such as buying a property with a residential element to it, which is not permitted. Unauthorised transactions result in stiff penalties, so they are worth avoiding!
- You might identify a great property in a great location and it could be perfect for your business to trade from, for the next 10 years or so. If the lease is short, it might be difficult to sell the property later.
My company needs a new office. Can I use the buildings for my company?
Absolutely, yes. This is a very popular use for properties acquired within Self-Invested Personal Pensions. Your pension needs to set a lease with your company on normal market terms. This means that your pension can't set the rent too low (which would be unfair to your pension), nor can your company pay rent that's too high.
What could go wrong?
These are the most likely pitfalls and risks that I can foresee:
- If you buy a property that is very cheap, the fixed fees for the transaction will mount up and will seem to be quite high, so the tax-efficiency of the plan might be a bit weaker for you.
- If your company sells its property to your pension, it might regret losing an asset that it could use as security for the bank at some stage. (Depending on your point of view, that could be a big advantage instead!)
- If you or your company could afford to buy the property so you don't need your pension to acquire the property, remember that the pension adds a layer of administration and compliance rules. For example, your pension will need to act as a responsible landlord - for example issuing energy performance certificate, You needn't worry about that if the company owns the property itself.
- Owning a property will bring greater responsibility than being a tenant, which you might not enjoy if you don't like 'red tape'.
- This strategy does increase risk for you; you could lose your pension if you make an imprudent property purchase, especially if you gave up safeguarded benefits, such as a final salary pension scheme.
- Your pension will lose out on rent if your company falls on hard times. In those cases, your wealth would suffer twice with losses in your business and your pension.
- There could be periods of no sitting tenants resulting in loss of regular income.
Does my pension have to buy the property on its own?
No. some Self-Invested Personal Pension providers are happy to let your pension and someone else's pension buy a property together. This can be multiple buyers. For example, we sometimes see partners in a GP practice, dentists, architects or solicitors joining forces to buy together.
What should I do next?
Think about what you are trying to achieve;
Is this a good form of investment for your pension?
Or a great way to secure trading premises?
Then think about what pension provision you already have; what benefits you might be giving up if you are thinking of using your existing pensions.
Get in touch if you'd like some help.