Sitting on a tax-free investment

Last year Pointon York conducted some research into pension fund ownership among accountancy firms. Somewhat surprisingly, over a third of qualified accountants in the sample held policies with Equitable Life.

While the Equitable debacle has no doubt focused the minds of professionals and the clients they advise, I’m still intrigued that many accountants in practice don’t know more than the basics about Sipps (self invested personal pensions). The case for Sipps is overwhelming.

And I believe firmly they should form the foundation of any coherent wealth management/preservation strategy for accountants and their clients.

Let’s go over the facts. Like all pension schemes, Sipps are money purchase arrangements which are subject to the same contribution limits of between 17.5 and 40% of net related earnings depending on age.

Sipps also enjoy the same tax benefits such as tax relief on contributions at the individual’s highest marginal rate.

In contrast to standard pension schemes, Sipps let individuals become their own fund managers: investing in their own choice of stocks, shares, gilts, bonds, futures and options, unit trusts, insurance company managed and unit-linked funds. They thus allow considerable flexibility and control to investors, who can switch between investments within a tax-sheltered environment.

Of course, investors can always put the selection of investments in the hands of specialist managers if the notion of acting as their own fund manager doesn’t appeal.

However, the real bonus with a Sipp is the ability to use it as a vehicle for raising a mortgage to purchase commercial property and then shelter the capital gains and rent tax-efficiently, allowing your pension fund to benefit from the growth that exposure to the property market brings.

With the availability of mortgages of up to 75% of the property’s value, large sums of money can be invested in commercial property, either for one’s own use or for renting to third parties. The rental income can be paid into a Sipp, can be used to buy other investments or, of course, to provide a useful income stream at retirement.

Since they began, Sipps were popular with switched-on professional partnerships.

The partners soon learned that by clubbing together they could hold their own property in a collective Sipp producing a number of attractive tax advantages.

In a typical example of how a Sipp might work, partners in an accountancy firm decide to buy a commercial property for £250,000.

A mixture of funds from both the group Sipp and a mortgage is used to fund the property purchase. The Sipp trustee then agrees a commercial rent which the partnership pays gross into the Sipp as payment for the partnership’s use of the premises.

Each scheme member has a personal bank account for his personal contribution and a separate property bank account is opened to receive the rent each month. The property account is also used to make monthly mortgage repayments and pay any other property related expenses.

All legal costs and disbursements made in connection with the property purchase are paid from the Sipp fund. Added to this where a commercial property is purchased subject to VAT, this can be reclaimed – as can any VAT expense. But this does mean that the rental raised on the property will be subject to VAT as well.

When a scheme member turns 75 the rule regarding the mandatory purchase of annuity applies – just as with an ordinary personal pension – and all assets must be sold. Fortunately there is a growing lobby to abolish the annuity requirement so most future retirees may be able to draw down a pension indefinitely.

When a partner dies or retires, it is possible to sell a share of the property to other partners or arrange for a new partner to take over a share, provided they made an appropriate contribution. Either way cash can be released to buy an annuity or fund a draw down arrangement.

Of course, don’t just buy property because you’ve been blinded by the possible tax savings. If you are buying commercial property, first of all make sure that the investment makes financial sense in its own right – a building in the wrong place is a bad investment whatever tax concessions are granted.

But, if like myself, you believe over the long term, property in the right locations will continue to grow in value, then with mortgages at today’s low levels, time is right to consider commercial property as part of your retirement provision.

One word of caution: the fact that Sipps include the words ‘self invested’ might be taken to imply they are a do-it-yourself form of tax minimisation strategy and are simple to set up and simple to run. In fact, Sipps are very complicated instruments and require a high level of sophistication on the part of the investor.

I would urge anyone who finds them an attractive option to seek experienced advice. More importantly, choose a provider who knows what they are doing. This is a particularly key point if property is involved.

• Geoffrey Pointon is the chief executive of Sipp specialist Pointon York. DIFFICULT QUESTIONS What happens to my fund if I die? The answer to this is complicated in that if the entire fund has resulted from personal contributions (rather than occupational transfers in) and no benefits have been taken, the whole fund value, tax-free, may be passed to the person(s) who have been nominated under the expression of wish, at the trustees’ discretion. If benefits are being taken, different options apply. Can I take cash from my fund without buying an annuity? Yes, if you are over 50, up to 25% may be taken as tax-free cash. An income would also have to be drawn and this would be based on IR figures. Occupational money that may have been transferred to the SIPP would impact on the benefits that can be taken. What can I invest in? Any foreign stock exchanges? The list is long, all recognised stock exchanges are permitted. AIM is permitted, but OFEX is not. Commercial property is a popular investment; hotels and nursing homes are permitted, but holiday homes are not. Residential property is generally excluded. My fund has grown a lot since I set up the income withdrawal arrangement. Can I take an increased income, above the maximum level set two years ago? No. But if you wish to have the figures reworked now, rather than wait for the three-year review, it may transpire that the resultant income figures are higher than those set two years ago. But you should bear in mind that although you are two years older and therefore the rates are higher per #1000 of fund, this could be offset if gilt yields have dropped. On the other hand, gilt yields are more stable than some years ago and it may be that with the increased value of the fund a higher income would result.