This article appeared in the Yorkshire Post on Monday 1st August, 2005. 

G&E Taxing Times - Using property to invest for a pension

Duncan Meredith G&E Tax Consultant

Judging from press coverage at least, two of the greatest obsessions in the public mind in the UK are property and pensions. Duncan Meredith, tax consultant in Garbutt & Elliott's Property Services Group, draws these two topics together.

Private investment in property, particularly in residential property, has become increasingly common over recent years. At the same time, many people have become disillusioned with the classic pension scheme method of saving for their old age. One of the common drivers for people investing in property is to build up an alternative form of pension fund. So, at present, property and pensions are seen as distinct alternatives. In the near future all this may change, because of Government changes to the taxation of pension schemes.

The Government was persuaded to make these changes by concerns that, as a nation, we are not saving enough to provide us with a living in retirement. The basic idea is to simplify the tax rules so that people will not be put off by the complexity. Instead of eight or nine different tax regimes, from 6 April 2006 there will be only one. All pension savings, whether company schemes or personal pensions, final salary or "defined contribution", will be subject to the same tax rules.

The new tax rules were set down in the Finance Act 2004, but there may be further changes in the Finance Act 2005 and possibly in 2006, before the rules take effect.

The advantages of pension schemes over other forms of saving are that there is tax relief on the contributions going into the scheme, and profits arising within the scheme are tax-free. The pension you draw at the end is taxable, but you can take up to 25% of the fund as a tax-free lump sum, limited to £375,000 from 6 April 2006.

From the point of view of the property investor, the main interest in the new rules is that pension schemes will have no restrictions on the type of investment they are allowed to make. At present, by contrast, approved pension schemes are simply not allowed to invest in residential property, with some very limited and uncommon exceptions. Typically, pension savings are placed in unit trusts or insurance bonds, which invest mainly in quoted shares and securities. Pension schemes also invest direct into stocks and shares. The stock market performance over recent years means that many people are worried about their pension funds and are looking for alternatives. This is, at least in part, what has brought about the shift of funds into residential property. From 2006 pension schemes will be able to invest in residential property.

So should you be looking to put residential property into your pension scheme in the future, to get the best of both worlds?

The answer to that question is that it all depends on your view of future trends in property values versus share values. On that matter, you need to take our own counsel and the advice of a professional investment adviser.

Another important point is that you will only be able to take advantage of the new flexibility over pension scheme investments if your scheme allows you to make your own investment decisions. There are two types of pension scheme that allow this. For small companies, a Small Self-Administered Scheme or SSAS will give you this control. As an individual, whether or not you run a business, you can use a Self-Invested Personal Pension or SIPP. But whether you use a SSAS or a SIPP, you will need professional help and advice to run the scheme, and that will cost money in the form of set-up costs and annual fees.

Another departure under the new rules is that you will be allowed to use pension scheme assets for private purposes. For example, if the pension scheme owns a holiday cottage, you will be able to take the family there for a holiday. This can't be done under the current rules. However, you will have to choose between paying a market rent to the pension scheme for using the cottage or paying tax to the Inland Revenue on the value of the benefit you enjoy. Most people will be likely to opt to pay the rent.

All in all, the regime for pensions from 6 April 2006 offers many interesting possibilities, and you should make an early appointment to speak to your pensions adviser if you haven't already done so.

Garbutt & Elliott are Chartered Accountants and tax advisers with offices in Leeds (telephone 0113 273 9600) and York (01904 464100). Duncan Meredith can be contacted at the York office, or by email to dmeredith@garbutt-elliott.co.uk.