* Source: Own calculation from statistics provided by Council of Mortgage Lenders (400,000 buy-to-let properties in UK) and Investment Property Databank (gross average annual b-t-rental 11,400, gross rental = 6.1% of capital value in 2003)
How will the market deal with these transactions without creating hassle for IFAs and their clients? To begin with, there are two ways to transfer a house into a pension wrapper – by the pension scheme buying the house and by in-specie transfer (See John Lawson on Pensions, Money Marketing February 24, 2005). The in-specie method looks superficially attractive but any outstanding mortgage on the property must be cleared before transfer. This will prove to be the biggest drawback of this method. Additionally, clients wanting to transfer a house in-specie will need to have earnings equal to the value of the house plus basic rate tax relief. Otherwise, transferring the property in bite-sized chunks is the only option – a costly process which will involve several changes of ownership. Some Sipp trustees may not even allow partial transfers due to the lack of control which part ownership creates. So it looks like the most practical method of moving houses into pensions is to build up the pension fund first and then buy the property. This method has the added advantage that the client receives cash in return for their buy-to-let, allowing them to settle any outstanding mortgage and capital gains tax bill. By using the new tax rules, a pension fund can be built up quickly (contributions up to 100 per cent of earnings in each tax year). But for most clients, a likely problem is cashflow. How many people can afford to save 100 per cent of their earnings every year over a three or four-year period? This is where borrowing comes in. Clients who need to borrow contributions will do so by using any free equity in their buy-to-lets or main residence as security. But they will need an understanding lender. Here, self-invested personal pension administrators need to think about creating a hassle-free process for clients. Any Sipp administrator who is serious about residential property will need to form a partnership with a competent lender. A lender that understands short-term secured lending, a lender that understands pensions and, most important, a lender that understands what the client is trying to achieve. The second time that borrowing enters the picture is when the pension scheme borrows against the accumulated fund. Here, the new tax rules allow schemes to borrow up to 50 per cent of the net fund (the net fund is the value of assets less existing borrowing). This type of borrowing is more like a traditional mortgage. Secured against the value of the pension assets, such borrowing will normally be longer term. To ensure quick arrangement of loans, good communication links between the Sipp provider and the lender will be needed. A slick process for approving loans allows the purchase of the property to happen more quickly. Clients anxious to repay loans and settle CGT bills will value a fast and efficient process. At present, few lenders really understand pension schemes and pension scheme borrowing despite the fact that small self-administered schemes and Sipps have been doing so for years. The reason for this is that lenders do not deal with pension scheme borrowing centrally. Instead, they choose to channel such transactions through their local branch or business centre networks. Consequently, bank managers are only likely to see one or two such transactions a year and, in many cases, none at all. This lack of frequency does not allow bank managers to gain a full understanding of pension scheme borrowing, resulting in a slow and cumbersome process. Therefore, lenders who want to take pensions seriously – and they should given the massive potential – need to develop a centralised and specialist unit to handle these requests. Only by doing so can lending staff build up enough experience to understand clients’ needs fully and offer a service to match. Much work is needed in advance of A-Day to build links between Sipp administrators and lenders. Educating lending staff will also be a priority so that they understand client’s needs. For those who are up to the challenge, the effort that they put in now will be handsomely rewarded. John Lawson is marketing technical manager at Standard Life.