Portfolio investors - should you combine property and pensions?
Do you, like many other portfolio owners, plan to use income generated from your properties to fund your retirement?
Income generated from buy-to-lets can offer a good alternative to saving into a traditional pension pot. Though in a recent article for FTAdviser, Claire Trott – head of pensions strategy at financial consultancy firm Technical Connection – discusses the idea of combining property and pensions instead, in order to achieve greater tax efficiency.
When combining property with a pension scheme, the money used to purchase a property will have benefited from tax relief. Saving up for the property will be easier as a result, particularly if employer contributions are involved. As the article notes, any employer contributions would also be subject tax relief, which can be of huge benefit to owner-managed firms.
The standard fees attached to purchasing a property will still apply, such as stamp duty, land tax and VAT. Yet, in the majority of cases, the pension scheme will be able to recover all VAT paid.
Perhaps the main advantage is that by receiving rental money into the pension scheme, the money won't be subject to tax. If you were to receive the rental money personally, on the other hand, then you would have to pay income tax on it.
The money saved could help to pay off a mortgage, if you have one, or to generate additional funds for retirement and investments. Also, if you wish to sell that property in the future, you won't need to pay capital gains tax if its value increases.
So far, so good. However, while combining property and pensions may seem like a savvy investment choice, there are several issues you need to bear in mind.
First of all, only commercial property is permitted in a pension without being subject to tax charges – though the term 'commercial' used in this context warrants further explanation.
In terms of pension schemes, properties such as bed and breakfasts and holiday lets are not classed as commercial, even though they are used for business. Generally speaking, if you can live in the property, it is deemed residential.
There are some exemptions to this rule, such as pubs. Many pubs have a flat on the top floor for the manager, so you would assume that it was residential. Yet if the manager is in no way connected to the pension scheme member and occupies the flat for their job, it won't be classed as residential – at least, in the majority of cases.
Tapered allowances and MPAA
The effect of tapered annual allowance for high earners, along with the Money Purchase Annual Allowance (MPAA) for those who have flexible access to their pensions, have resulted in pensions savings being considerably restricted for many people. This could impact how much can be saved to buy the property, though contributions may not be required once the property is part of the scheme.
Rental income generated from properties that are part of a pension scheme is considered to be growth in the fund, and consequently, won't be affected by the taper or the MPAA. In this way, the rental income you gain could be a great way to keep building your pension or generate an income stream when the annual amount you can pay in is limited.
There are concerns regarding the liquidity of property investments when someone wishes to retire, yet if managed well, this problem can be mitigated. Owners could choose to sell a property when they retire, but the market conditions may not be right, or the property could be linked to a business the owner will maintain into retirement.
The pension freedoms rules introduced two years ago provide improved flexibility in relation to the amount and timing of pension withdrawals. So, when you've built up rental income, it can be easily withdrawn as and when you need it, while missing several payments will not limit accessibility.
Ultimately, if you are thinking about combining property with pensions, the most important thing is to identify a suitable scheme that can deal with your investments. Seeking professional advice at this stage could help with your decision.
While Stride may not be able to advise on pension schemes, we can help you to protect both your money and properties by providing you with portfolio insurance. With decades of industry experience, you can rest assured that our service and products are of the highest quality. Why not get in touch today to find out more?