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John Lawson on pensions

Accepted knowledge of what is possible under the new pension tax rules is still very much a moving feast. This is likely to remain the case for the foreseeable future.

One of the latest revelations concerns what does and does not count as a pension contribution. The Finance Act 2004 seemed to be pretty clear that the only forms of payment that would qualify for tax relief after A-Day were cash and the transfer of certain shares, for example, shares from a save-as-you-earn scheme. The fact that there is a specific section of the act (195) that deals with these share schemes suggests that the other sections dealing with contributions and tax relief are talking about cash.

Now it would appear that one could use any asset as a contribution after A-Day, including houses. This all hinges upon a new legal interpretation of the Finance Act. The new interpretation outlines a two-stage process. First, the person making the payment states how much the contribution is as a monetary amount. For example: “This is a payment of 100,000.” The second stage is then to pay in an asset of equivalent value to the stated monetary contribution.

It is worth sounding a cautionary note. As noted above, it was clearly not the intention of the Inland Revenue to allow such in specie contributions. This means that they could either change the Finance Act or refuse tax relief when the new rules come into force. The latter of these two options would probably have to be decided by the courts.

Even if people can pay a house as a contribution, this method of transferring one’s property into one’s pension fund is not without problems. Unless the individual has earnings equal to or greater than the value of the house, then it would have to be paid in a bit at a time. This would involve several changes of ownership, with legal costs in changing title, admin costs in recording the change in ownership and other costs, such as drawing up a new lease, incurred with each portion transferred. For this reason, such a method of paying contributions will be expensive.

The second problem is cashflow. Before using a property as a contribution, any existing mortgage would need to be repaid but because the pension scheme is not buying the house, the saver rec-eives no consideration from the pension scheme in return for the house. This means that the existing mortgage will have to be repaid from other sources of capital.

Because of these problems, people are likely to prefer the pre-funding method of transferring property into their pension fund. This method relies upon building up sufficient funds within the pension scheme before the property is bought. The fund would be built up from a combination of contributions, tax relief and pension scheme borrowing.

The big advantage of this method is that when the individual sells the house to the pension fund, they get cash in return. The cash can then be usefully employed to repay existing borrowing, pay any capital gains tax bill and cover legal fees.

Regardless of which method is used, capital gains tax considerations are similar. If ownership of the property is transferred to the pension scheme in one transaction, then the capital gain is assessed in the tax year of transfer. Although more expensive in terms of legal fees and admin costs, transferring the ownership of the property in stages means that the capital gain arises on a gradual basis. This will allow the saver to offset the gain against their annual capital gains tax allowance in two or more tax years.

The pension scheme administrator also needs to permit part-ownership of the property. Administrators may be unwilling to allow part-ownership as it could lead to disputes over issues such as the standard to which maintenance is carried out. Advisers therefore need to keep a watching brief rather than taking clients down a particular path at this stage.

Note: Tax and legislation are likely to change. The information given here is based on Standard Life’s understanding of UK law and Inland Revenue practice at the date of publication and the legislation we believe will apply from April 6, 2006.

John Lawson is marketing technical manager at Standard Life

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