Commercial property is a popular self-invested personal pension (SIPP) investment, but what happens if an investor dies holding a property? This case study explores the options available to beneficiaries who are due to inherit a plan holding property.
Elias, 76, and Rita, 72, were former business partners. Their business is now run by Elias’s daughter Ada, and Rita’s children Lucas and Imogen.
Elias and Rita both recently passed away in quick succession, each with their children names as the beneficiaries for their plans. Each still held one of the business’s properties in their SIPPs when they died.
Rita’s SIPP held a property worth £500,000 and a few hundred pounds in cash. Elias’s SIPP held a property worth £300,000, approximately £90,000 of other assets and £10,000 of cash. Both SIPPs were fully crystallised.
Ada, Lucas and Imogen all have relatively modest pension provisions of their own. The business is performing well and they are keen to keep the properties in their ownership. They arrange a meeting with their financial adviser Arjun to discuss their options.
First of all, Arjun gives an overview of the group’s situation and options. He explains that the SIPPs are outside of Rita and Elias’s estates, and therefore won’t be included in any inheritance tax calculations. He also explains that each beneficiary has the option of taking their share as a lump sum death benefit, or establishing a beneficiary’s drawdown account. Arjun then decides to look at each case in turn.
Rita’s expression of wishes asks to split her plan 50/50 between Lucas and Imogen. Both are keen to keep their share within a pension. Arjun explains that Rita’s SIPP provider will administer this by establishing a beneficiary’s drawdown account for each of them, and allocating 50% of the property ownership to each plan. Going forward, each plan will pay 50% of the property fees and receive 50% of the rental income.
Arjun then explains that as Rita died before turning age 75, any income Lucas or Imogen withdraw from their accounts will be free of income tax. They can take tax free income from any surplus cash which builds up within the accounts, although they will need to be careful to leave enough liquidity for fees and other expenses which may arise.
Ada is less familiar with the idea of holding a property in a pension, and thinks she would prefer to take the second property out of her late father’s plan as a lump sum and own it personally. However, Arjun explains that this might not be the best options for her, and may not be possible.
Arjun explains that as Elias was 76 when he died, the death benefits paid to Ada will be subject to income tax. As she is already a higher rate tax payer at the upper end of the band, most of the £400,000 would be subject to 45% tax. Elias’s SIPP provider must pay this tax charge to HM Revenue & Customs before distributing the benefits, so the SIPP would need almost £180,000 in cash in order to pay the remainder as a lump sum.
Ada asks if she could purchase the property from the SIPP herself. Arjun confirms that this would be possible, but as Ada does not have the money available, she would have to borrow in order to do so. She could then take the pension as a lump sum, but after tax there would not be enough cash to pay off the whole loan.
Arjun explains that if Ada leaves the property in a beneficiary’s drawdown account, she does not have to pay any tax up front: she will only pay tax on income she chooses to withdraw. The property will also benefit from the same tax advantages as Elias’s pension: the SIPP will receive rent tax free, the property is outside her estate for inheritance tax purposes, and if she chooses to sell the property in the future she won’t pay capital gains tax on the profit.
Ada, Lucas and Imogen all decide to keep their inherited funds within SIPPs and hold the properties within them. This allows them all to keep the properties in a tax efficient environment, and allows Ada to minimise the tax she might pay on the inherited funds.
Jessica List is pension technical manager at Curtis Banks Group