Commercial property investment via a self-invested personal pension (SIPP) can be very tax efficient. However, clients do worry about what will happen when they want to retire or if they were to die suddenly.
Mr Wood aged 62, Mrs Wood aged 60 and twins John and Tracey Wood aged 30 are members of a joint SIPP. It has a property worth £250,000 (from which £20,000 p.a. rental income is received), and cash deposits of £20,000. Mr & Mrs Wood each own 40% of the property and cash and the twins each own 10%.
Mr & Mrs Wood would like to retire from the business within the next three years. They want to know how they extract their 25% pension commencement lump sum (PCLS) and regular income. Additionally, Mr Wood has been diagnosed with a heart condition and is worried about what would happen if he died.
How do they extract their 25% PCLS and regular income?
In three years’ time, let’s assume the property is worth £300,000 and the cash in the bank has increased to £80,000. So total assets are £380,000, with Mr & Mrs Wood each being entitled to 40%, or £152,000.
Mr & Mrs Wood are each entitled to £38,000 PCLS. However, although there is £80,000 on deposit, their 40% share of the cash deposits is only £32,000 each.
As SIPP assets are earmarked their PCLS entitlement could be achieved via the twins, John & Tracey, who are happy to have a greater share of the property asset. This would be structured as follows:
- They agree an “asset exchange” swap within the joint SIPP with Mr & Mrs Wood
- The company make a contribution for both John & Tracey to the joint SIPP to cover additional funds and / or
- John and Tracey make personal contributions to the SIPP to increase cash funds
- John & Tracey can also use some of their existing cash in the joint SIPP bank account
“Asset exchange” means the property asset ownership held within the joint SIPP can be changed without selling the property.
In brief, if one member can bring more cash to the table within the pension then the members can agree to exchange this for a higher property ownership. It’s worth noting that this is subject to an independent valuation of the property asset at the time to ensure commerciality and prevent any tax charges arising on the exchange.
It should also be noted that, depending on the value of the assets exchange, there may be stamp duty implications.
By having a joint SIPP and undertaking asset exchange, John and Tracey increase the liquidity available for their parents to access their PCLS and income drawdown. It also enables the property to be retained by the family business within the tax exempt pension fund. The children can continue to build up their pension funds through annual pension contributions from the company, thereby reducing corporation tax.
What would happen if Mr Wood died?
If Mr Wood were to die suddenly his wife may want to take a lump sum payment. The SIPP would not have enough liquidity to pay this out immediately, but it has two years to pay out the lump sum death benefits tax-free (if Mr Wood has not reached age 75 when he died), but it will need to raise its liquidity.
There are four ways to increase this liquidity:
- The property can be sold to the company or to a third party, raising cash so benefits can be paid out. A possible downside here is that the other members swap their main pension asset for cash and, if the property is sold to a third party, they may no longer have control over their business premises.
- Sell part of the property to the company or to a third party. The aim would be to sell a large enough part to raise enough cash to pay out the death benefits for the deceased member.
- Borrowing could be arranged using the property as security, the borrowing repayments could be made from the rental income.
- Asset exchange. As explained above, the property asset ownership held within a joint SIPP can be changed without selling the property.
Alternatively, if Mrs Wood did not need the cash lump sum she could take the death benefits as dependant’s flexible drawdown pension.
The property would be retained in the joint SIPP and Mrs Wood would have both a widow’s pension pot that contained part of the property along with her share of the property in her own pension pot, drawing income as required (subject to liquidity).
As Mr Wood had not reached age 75 all future pension income would be paid tax-free where this was designated within two years of the death.
John Keenan is corporate development manager at Xafinity SIPP & SSAS