Indisputably, pensions have a powerful tax advantage, but if you’re a director or owner of a small business, the company’s assets could help you generate a bigger pension fund faster.
The boost is achieved by holding your business premises within a pension wrapper. Once those premises (including any commercial or agricultural land) are ‘owned’ by the pension, they can be leased back to the business and, significantly, rent paid by the business can go directly into your pension pot.
“There are big tax advantages,” says Ian Price, Divisional Director, Retirement Proposition at St. James’s Place. “Rent paid into the pension is free of Income Tax, and there’s no tax on capital gains when it’s time to sell up.”
The tax breaks mean that business owners can build their retirement nest eggs quicker, especially if tax-relievable contributions are made from income.
Building on success
The commercial property market has been performing well over the past few years, owing to improving economic conditions and low interest rates.
“As demand has increased, we’ve seen rents and valuations rise,” says Price. “Although prices may have peaked, fundamentals remain strong.”
Of course, good performance shouldn’t be seen as a guide to the future, since there will be years when property falls in value.
Putting capital gains to one side, however, it may be that the decision to move property into a pension wrapper is validated by the combination of tax benefits and pension freedoms; these include the availability of uncapped income from age 55 and the possibility of mitigating death taxes altogether.
Only a self-invested personal pension (SIPP) and a small self-administered scheme (SSAS) can hold commercial property. Many business owners will have insufficient funds to purchase their premises outright, so they can face the challenge of borrowing money to acquire the property. The rules allow investors to borrow up to 50% of the value of their pension pot to fund the purchase.
Once everything is established, there’s also the task of making sure that rental income is invested appropriately.
“It’s probably not the wisest move to let cash accumulate in the fund when you consider the derisory rates of interest on offer versus the longer-term potential of a typical balanced portfolio of investments,” says Price.
Remember also that property tends to be illiquid when compared to other investments. It could take months, or even years, to sell the premises at the right price – the market might be down at just the moment you want to sell.
These are just some of the reasons that directors and owners of small businesses should seek advice from a specialist before taking action.
One increasing challenge was the introduction of a reduced lifetime allowance of £1 million in April 2016. Price argues that anyone holding substantial wealth in a pension needs to monitor its value, as savings above £1 million are taxed at 55%.
“If the lifetime allowance becomes an issue in the future, business owners could consider taking their pension benefits earlier, sell the property and invest in an asset further down the risk scale, or accept the tax implications,” says Price.
“But my main observation is that monitoring the situation with a financial adviser is imperative to achieving the best outcome and mitigating unnecessary tax.”
SIPPs and SSASs tend to have higher costs than standard pensions and active management is essential to maximise the benefits of the wider investment choice on offer. For these reasons, they will not be suitable for everybody and generally only those who are fairly experienced at actively managing their investment should consider this type of investment.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.