Raising Cash for Property Investment - Part Five

In part one of this series, Raising Cash for Property Investment, I looked at how dramatically the financial world has changed in the last four years and how this has impacted the property investment market. We considered the ways to raise cash by using your home as a capital asset. In part two we checked out ways to recycle your money; in part three we considered many other possible sources of cash; and in part four we covered joint ventures.

Now, in the concluding part of 'Raising Cash for Property Investment' we will turn our attention to a resource that you may not even know you possessed - your pension!

I am not an FSA approved financial advisor and therefore this is not advisory information directly specific to you. Rather, it is my personal, overview opinion. You MUST consult with your approved IFA and/or your personal accountant before making any decisions regarding your pension. The consequences of making a good decision are very positive. The consequences of getting it wrong could badly impact your future for the rest of your life.

Basic pension understanding

Before we get into the detail, I believe it will be helpful to explain some basics about pension provision and what is actually happening in the market today.

The concept is simple. There is generous tax relief to save money into your pension during your working life. If you are self-employed you will have to make all the contributions yourself. If you are employed your employer may contribute to your pension as well.

If you stay within the rules, your contributions will be allowed against tax at your highest rate; and the profits made within the money invested will also be tax free.

At the time you retire (and you can usually choose when subject to a minimum age) then you are advised of the value of your 'pension pot'. This will be all the contributions you have made, your employer has made, plus the accumulated profits from investment over the years. Deducted from this are charges that have been levied against your pension over the years.

What happens to your pension pot?

Under current legislation, you have the option to take up to 25% as a lump sum. The remainder (or all if you prefer) is used to buy an annuity in the marketplace.

An annuity is simply a monthly sum for life. If you live to a ripe old age you will do very well from an annuity. If you die early then the annuity provider does well instead.

The annual annuity will vary depending on your age at retirement, whether you want your pension to increase with inflation and whether you want your partner to get a pension after you die.

It's important to understand there is no value in an annuity when you die. Your pension 'pot' is not available to your heirs or other inheritors.

What kinds of pension are there?

Basically, there are two types of pension. The very best, although increasingly uncommon except in the public sector, is a 'final salary scheme'. This kind of pension guarantees you a percentage of your final salary which depends on your years of service and seniority. The rules can be complex, but the bottom line is that your pension is guaranteed at a certain level, regardless of the underlying performance of the pension fund that you have been contributing to.

For around the last 15 years, the pension funds underlying final salary schemes have not been making good enough returns to justify paying the guaranteed final amounts. In some companies, such as British Airways, the gap between the value of the fund and the potential requirement to pay pensions is simply enormous - running into £ billions!

This massive shortfall has caused most private companies to close final salary schemes. If you are fortunate enough to be in such a scheme - please realise how valuable it is. It would be extremely rare for ANY other investment proposition - including property - to beat the guaranteed final pension that you can expect.

The second (and most common) type of pension is a money purchase scheme. This simply means that, whatever the value of your pension pot when you choose to retire, this is the amount which can be used to buy an annuity. So it reflects exactly the performance of the underlying fund. For many reasons and for many years, the investment performance of pensions has been dire (and I do mean DIRE)!

Why have pensions underperformed?

Here are the key reasons. Some are related to the growth (or lack of growth) in the fund whilst you contribute. Others are related to the annuity you can buy when you retire.

Issues related to the fund

Charges - on a recent Panorama programme, a number of investment companies offering pension provision were asked about total charges over the lifetime of a pension. This included up-front fees, annual fees and exit fees. Many companies took more than 40% of your entire contributions as charges; and one bank admitted that they took more than 80% of your pension contributions in charges.

Low interest rates - some of your pension pot is usually held in 'gilts' and other interest related deposits. With interest rates at rock bottom, the investment return on such instruments is terrible.

Poor investment performance - most of your pension will be invested in stocks and shares. From 2000 to 2012 the returns from shares has averaged -14% over the entire 12 year period! (Barclays Capital calculation). Far from increasing your investment, it has decreased.

As if these problems are not enough, consider the challenges when you want to take your annuity.

Extended life expectancy - as we live longer, the years that your pension has to be paid increases, so the amount that you receive annually decreases.

Low interest rates - the company providing your annuity can't invest for a high return.

Poor investment performance - again, poor returns decrease the amount that can be paid to you.

If you add all these points together, the ultimate result is that pension returns have fallen 30% in the last 10 years; and are expected to continue to fall.

Enter the SIPP

A SIPP (self-invested personal pension) is the Government’s way of widening the type of investments which can be made and giving individuals more control over how their pension is invested. SIPPs are regulated by the FSA and the rules are quite complicated, therefore you should see your IFA for full details.

The most important piece of learning is that just because an investment is FSA approved for a SIPP, it does NOT guarantee it as a 'good' investment! Due diligence on the part of the investor is still required.

On the positive side, the much wider range of qualifying SIPP investments means that the careful investor can almost certainly do far better than the appalling performance of most traditional pension providers. However, a reminder that if you are in a final salary scheme it will mostly be wrong for you to exit. Please take advice from your IFA regarding your individual circumstances.

How to invest in a SIPP

Here's where it gets interesting. If you have been paying into an underperforming pension for years, you will have a pension pot building up. The Government allows you to take the pension pot and re-invest it in a qualifying SIPP.

Your pension provider might not like this, but in almost all cases they are legally bound to allow you to do so, although the process can be long winded and a bit cumbersome.

A second approach is that if you are already investing in a SIPP, but one with shares as the underlying investment model, then you may be able to transfer to a new SIPP invested in property related products.

A third approach is to contribute new money directly to your SIPP, which will then invest in SIPP approved investments as you direct.

To summarise, there are three ways to invest in a new SIPP:

1. Transfer from an existing 'traditional' pension.
2. Transfer from an existing SIPP.
3. Set up a new SIPP with cash.

What can you invest in?

Perhaps surprisingly, the most secure and safe investment in property. Whilst residential buy-to-let is not allowed under current SIPP regulations, there is a wide variety of property related investments which are SIPP approved. These include:

• Property development
• Car parks
• Self-storage units
• Hotel rooms
• Farm land
• Bamboo and teak plantations
• Commercial property including offices, warehouses and shops

Your investment can be UK based or international; and it is permissible to invest in 'fractions' as well as complete properties.

However, remember to complete due diligence because the performance of the underlying investment is key to your future!

Summary

Using your pension to invest in property related assets is doable and can be beneficial for most people in a 'money purchase' pension scheme. The SIPP wrapper allows a variety of investments to be accommodated, but is no guarantee of quality or future investment performance. As always due diligence is key!

As always, if you have any comments or questions I'd love to hear them. Email me at rod@axiscontact.com for a personal reply.

Live with abundance,

 Rod Thomas FCA

Posted in Finance & Money

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