How to buy commercial property using a SIPP
Harness the power of pensions
As a pensions actuary, I’m well aware pensions don’t have the sexiest reputation. In fact, most people would rather talk about your recycling habits than pensions. However, I’m a strong advocate for financial responsibility and retirement planning. So, I feel duty-bound to spread the word about pensions and highlight the benefits they have to offer. So, I’d like to talk about how you can using a SIPP to invest in commercial property and other investments. This could be as a supplement to other property investment activities or in place of them. I can’t promise to make pensions any sexier. However, I can promise that by the end of this post, you’ll have a much better idea of where to start and how to go about it, if you want to harness the power of pensions to help you meet your property goals.
Why use a SIPP to invest in commercial property?
A pension is a fund you pay money into while you’re working and take money out of after you retire. There are lots of different types of pension, including state pensions, company pension schemes, and personal pension plans. Here, we’re just going to discuss one type of personal pension available in the UK known as a self-invested personal pension (or SIPP). You can use a SIPP to invest in property. But before we get into all that, let’s look at why you might consider using a pension to save for your retirement.
1. Tax relief on contributions
You can get tax relief on pension contributions up to 100% of your annual earnings. Depending on the type of pension plan and whether you’re a higher rate taxpayer, you may need to claim some or all of this back via your self-assessment tax return at the end of the year.
2. Tax-free investment returns
While your savings remain in the pension plan, any investment returns earned by the fund are not subject to tax.
3. Tax-free cash lump sum
When you retire, you can withdraw up to 25% of the fund as a tax-free cash lump sum. You can use the rest of the fund to provide an income, which you’ll then pay income tax on.
How to use a SIPP to invest in commercial property
A self-invested personal pension (or SIPP) is a government-approved personal pension scheme available in the UK. It’s a ‘tax wrapper’ that has all the same tax advantages we discussed above. That is, it allows tax rebates on contributions. However, it allows for a much greater choice of investments than other personal or company (occupational) pension schemes. As such, you can use a SIPP to invest in property / commercial property to a greater extent than with other types of pension plan.
How are SIPPs structured?
From a structuring perspective, SIPPS are single-member personal pension plans. They are usually set up under a master trust framework. That is, there is one legal trust and one trustee board that governs the plan. This helps keep operating costs lower, but it allows the plan to retain a strong governance framework. The SIPP provider normally acts as the trustee and has certain responsibilities. Some SIPP providers also appoint the member (that’s you) as a joint trustee, but this is less common. The provider has overall control and is in charge of the day-to-day operations. The investments are registered in the name of the trustee, and the provider decides which investments are allowable. However, it’s the member (you) who makes the investment decisions. As such, a SIPP is a product for sophisticated investors who know what they’re doing and want full control of their investments.
What kinds of investments are available?
A SIPP has a much wider range of investment powers than other types of personal pension. In general, the SIPPs that allow their members to hold specialist investments like property will have higher charges. So, you will pay for this greater flexibility. SIPPs can also borrow money to purchase investments. For example, you could raise a mortgage to part-fund a property purchase through your SIPP. So, it is possible to use some leverage, but there are limits around how much you can borrow. The general rule of thumb is you can borrow up to 50% of the value of your SIPP to finance a commercial property investment. In general, you can use a SIPP to invest in the following types of assets.
Stocks and shares
You can buy stocks and shares, as long as these are listed on a recognised stock exchange.
Government and corporate bonds
Government bonds (e.g. UK government gilts) are loans made to the government. Corporate bonds are loans made to companies. They usually pay interest and a return of the borrowed monies.
Investment funds
You can invest in a wide range of collective investments, including property funds and real estate investment trusts (REITs).
Commercial property
SIPPs can invest in all the usual types of commercial property, including retail, office and industrial buildings. They can also be used to invest directly in commercial property, not just through commercial property funds.
Land
You can invest in agricultural land, woodland, or land that has a commercial use, e.g. access roads, car parks, etc.
Gold bullion
SIPPS can invest in gold bullion, provided that the gold is ‘investment grade’.
Derivatives
You can also use a SIPP to invest in derivatives like futures and options that are traded on a recognised exchange.
So, the range of potential investments is vast. However, there are also some restrictions. For example, there are investments that are permitted by the primary legislation, but which were subsequently made subject to heavy tax penalties. This includes ‘exotic’ assets like vintage cars, wine, stamps and fine art. It also includes residential property, unfortunately. In practice, therefore, most SIPP providers don’t allow you to hold any residential property. This includes buy-to-lets, HMOs, and residential ground rents. From a property investment perspective, that means you’ll mainly be able to use your SIPP to invest in direct commercial property investments. You can also take a stake in any property funds permitted by your SIPP provider.
What fees will I pay?
Each SIPP provider will have their own fees. The charges can be extensive, so you need to check these out carefully before you pick a provider. SIPPs come in a variety of shapes and sizes with vary pricing structures and fees. However, I would divide them into two main camps.
1. Low-cost SIPPs
Most investors prefer these, but the investment options are limited. They give you access to anything that can be easily traded on an online platform. At the simplest end, these SIPPs are limited to investment options like unit trusts and other pooled investments. If you want to hold complex assets, e.g. commercial property, you’ll need to look elsewhere. Fees include an annual fee, set as a fixed fee or a percentage of your portfolio. There will also be dealing fees for buying and selling stocks or funds.
2. Full SIPPs
These SIPPs offer the widest range of investment choices. They allow you to invest in commercial property and trade stocks and options on a stock exchanges. They also allow you to invest in gold bullion and take stakes in hedge funds. The priciest SIPPs even allow trading in risky commodities. Fees for these SIPPs typically include a set-up fee of several hundred pounds. They will have an annual fee set as a fixed fee or a percentage of your portfolio, which can run to hundreds of pounds per year. If you invest in commercial property, there will be all kinds of extra set-up costs and fees for annual management.
When it comes time to take your pension, there can be extra costs and charges like drawdown fees or exit-transfer fees. For example, there can be charges for transferring funds into or out of your SIPP. This is an area you’ll want to try to understand upfront, before you go down the SIPP route. It’s also an area where an Independent Financial Adviser (or IFA) can add a lot of value. An IFA can help you get this set up the right way and make sure you’re running things efficiently from a tax and fees perspective.
Keys to success when using a SIPP to invest in commercial property
You now have a better feel for the different types of SIPP and how they work. So, let’s look at some of the keys to success, if you use a wan to use a SIPP to invest in commercial property.
Pick the right type of SIPP
The range of SIPPs on offer can be overwhelming. So, it helps to narrow down your choices if you know what you want it for. If you simply want to invest in property funds and REITs, a low-cost SIPP will do the trick. If you want to invest directly in commercial property, you’ll need a full SIPP that allows this option.
Take advice from an IFA
If you’re thinking of setting up a SIPP, make sure you take advice from an IFA to ensure you set this up in the right way. This is particularly important if you’re thinking of transferring an existing pension pot into a SIPP product, as pension transfers can be complex. You need to fully understand all the impacts here. A good adviser will be there to support you in your decision making and help to make the right choices.
Work with a reputable provider
Although SIPPs are portable, you want to be working with a reputable provider from the start. Some providers will be new to the market, others will have been providing this service for years. You should research the different providers, understand their strengths, and make sure that the SIPP they provide can do what you want it to do. Again, an IFA should be able to help here.
Understand the fees and charges
Understanding the fees and charges is important. You should make sure you read and understand the provider’s terms and conditions and that you are fully up-to-speed on the costs. If you don’t understand how a particular fee or charge works, speak to your IFA or to the provider and ask them to explain it. This is particularly the case when you’re investing in commercial property using a SIPP. Here, there will be fees on purchase and sale, taking out a mortgage, and administration fees. There will also be fees for ongoing management, such as VAT returns, mortgage fees, rent reviews, etc.
Understand the governance
You’ll want to understand how decision making and governance works for your SIPP. For example, can you liaise with the provider directly, or will you need to do this through an IFA?
Think about your exit strategy
You need to check the SIPP will allow you to draw your pension in the way you want. For example, some providers allow flexible drawdown (drawing a pension in instalments) and some don’t. Make sure you’ll be able to access your funds in the way you want when it comes to retirement.
Finally, I want to stress again that if you’re thinking about transferring an existing pension pot into your SIPP, you should take independent financial advice from a qualified IFA. This is even more important if you’re thinking about taking a transfer from a defined benefit (“DB”) pension plan. That’s the technical name for older types of UK pension plan that often provide pension benefits linked to your salary and years of service for a company. These DB pension benefits can be very valuable, and the decision to take a transfer can be complex. Again, an IFA will be able to help you understand the financial impacts of taking a transfer from a DB scheme.
Reversal
If you only have a small pension pot, you’re unlikely to find it cost effective to use a SIPP. With the cost of opening and running a SIPP potentially running to hundreds of pounds each year, it’s not going to be worth it, if you’ve only got a few thousand pounds to invest. If you’re in this category, a more cost effective and still somewhat tax efficient strategy might be to invest via a stocks and shares ISA, where any investment returns earned will still be exempt from tax and you won’t pay tax when you withdraw funds. With an ISA, you’ll be able to invest in property funds and REITS. However, you won’t be able to invest directly in commercial property.
For more on using a SIPP in invest in commercial property
That brings us to the end of this post on investing in property and commercial property with a SIPP. This post is based on a chapter from our book, The Property Investment Playbook – Volume 2, which is available on Amazon. If you enjoyed it, why not check out the book.
Until next time, best of luck with your future property endeavours.