Client Case Study 1: Owner-Occupier Pension Property Purchase...
In my last blog, I outlined Engage’s investment philosophy. I received some really positive and unexpected feedback. I had some financial planners say that it was an excellent communication, and I had some people read the blog and ask me for the investment portfolio data.
So this got me thinking, if people really do want to see what’s under the bonnet let’s show some more detail.
I figured that a good way to demonstrate what we do would be to publish a series of client case studies. I will write these alongside the investment philosophy, so we can continue to be transparent with what we’re doing and how we’re doing it.
As I always state, I want to try to keep it very simple - so I’ll be giving an overview/highlights. If I was to include all the research, the meetings, the discussions etc, this blog would be more like a textbook!
Compliance note – the advice below was specific to a client I know well. I know their circumstances in detail and am therefore able to advise. There will likely be things I’ve neglected to mention from a compliance point of view in this blog but they will have been considered and covered!
The clients in this case study are a married couple in their 30s with three kids. They run a business as joint shareholders and they are comfortable from an income/earnings perspective. Their earnings are kept to around £100k each so they don’t lose their personal allowances. Anything the business generates over the £200k that they take as income builds up in the business, so they aren’t paying too much tax.
It’s a good strategy because they aren’t ramping up their lifestyle to match their income, they’re building up surplus funds for their future.
The husband and wife each opened pensions early on in their careers, but they haven’t been contributing in recent years.
The business they own has been renting an office building locally to where they live at c£30k a year. When we discussed some ideas of what “good” looked like for them, they spoke about really wanting to buy a building for the business to work from. They felt that the business was sustainable enough for them to take a calculated risk, some additional debt (mortgage) to pay down over time giving them a long-term income-generating asset.
The next step was to work out if this was achievable. We identified what kind of building they’d like to work from and approximately how much this would cost with both purchase price and renovations considered. Together we estimated £350,000/£375,000 in total would be needed. Obviously, this is outside of central London!
The business had around £300,000 of cash within it and we discussed using pensions to buy the property. The amount anyone is allowed to put into a pension in a tax year is 100% of earnings up to £40,000. However, if you haven’t utilised your full pension allowance in the current or previous 3 tax years you are allowed to ‘carry forward’ any unused allowance to the current year.
If a person hadn’t contributed at all over this year and the past 3 years (and had earnings of £40,000+), they could use up the £40,000 allowance for this year and for each of the previous 3 years – making a total contribution of £160,000.
There are additional issues here around the reduction of annual allowances due to high earnings but for the sake of simplicity, I’m not going to go there in this blog!
The clients liked the idea of utilising cash within their business and getting tax relief on a potentially large SIPP (self-invested personal pension) contribution. If you make a corporate pension contribution, the amount you contribute is taken off your company profit in that year. For example, if you made a profit of £100,000 and you make a £20,000 company pension contribution, your profit would reduce to £80,000, meaning you pay corporation tax on £80,000 rather than on £100,000.
So, we opened a joint SIPP with Mattioli Woods who are a SIPP provider specialising in helping with SIPP commercial property purchases. They aren’t the cheapest, but when considering a property within a SIPP, it’s my view that it’s more important to have people who understand the market and know what they’re doing! Most pensions are individual, however opening a joint SIPP allowed us to utilise both the husband and the wife’s allowances as a pooled asset.
My clients didn’t have enough cash to do a full carry forward of £160,000 each, so we made a SIPP investment from their company of £125,000 each (£250,000 total). We left £50,000 in their business for emergencies and cash flow.
As I mentioned before, this was a significant investment for them and as such, the SIPP contribution was offset-able for tax purposes. This saved the company c£50,000 in corporation tax.
So, we’d now opened a joint SIPP, we’d funded it with £250k and we were waiting for the property opportunity. In truth, my client had already seen something of interest and was negotiating during the set up of the SIPP. They’d found a building with a purchase price of c£260,000. There was scope to refurb and extend the ground floor and so a total spend of around £350,000 plus costs was estimated. To include stamp duty and other fees it would rise to around £370,000.
A further benefit of investing into a SIPP is that the rules allow a SIPP to borrow 50% of it’s net assets. Therefore, in this case it could borrow £125,000. This would give it a total value of £375,000. We used Santander for the loan which allowed the clients to purchase the commercial property and complete the refurbishment.
There were some fees attached, the SIPP required a valuation of the asset and Santander needed a valuation, both of which had fees attached, you have normal mortgage broker fees and an additional borrowing set-up fee due to the complexity. The interest rate is c3.5% over base - which is fairly competitive for a commercial mortgage. The set-up cost for Mattioli Woods was around £2,000. They have ongoing costs of around £1500 per annum as well to run the investment and regulatory requirements.
This client is a Tier 1 client with Engage - they pay £4,000 per annum. As such, this piece of work was outside of their fixed fee agreement due to the complexity of work, time spent and associated risk. Therefore, we agreed a one-off fee for this piece of work of £4,000. This meant that the total fees for the client for the entire project were around £10,000.
However, in perspective, the clients mitigated c£50k in corporation tax initially, then added value from the refurb and then had their business pay down the debt - whilst simultaneously funding their pensions. Hopefully you can see that - whilst it’s not a cheap option – it’s great value for money.
I’ve attached some pictures from the start of the project to the finish to show you the outcome, and below I’ve highlighted some pros and cons for buying a property within a pension.
Pros:
· No capital gains tax on a property sale within a pension
· No income tax on rent received into the pension
· SIPP assets are not accessible to creditors in case of bankruptcy
· Assets outside of the estate for Inheritance Tax
· SIPP can claim VAT back on development costs
· For business owners this is a tax efficient way of buying their trading premises and effectively paying the rent to themselves tax efficiently as there is tax relief on contributions received and rent paid by the business is a business expense so tax deductible but when received by the SIPP is non-taxable
Cons:
· The additional ongoing costs are higher for the complexity
· Added risk, if business goes bust you lose business and rental income
· Property is an illiquid asset class and could take a while to sell
· There is a lack of diversification within the SIPP
Hopefully you found this is an interesting read. Do get in touch if you have any questions or if you’d like any further information and I’d be very happy to discuss it in more detail.