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Thursday, 23rd January 2020
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Buying property in a pension plan - does it still work? Back  
Over the past number of years, a significant number Small Self Administered Pension Schemes (SSAPS) have been established with the intention of buying property. However, changes in this year’s pension may well signal a ‘slow death’ for SSAPS going forward, writes Declan Lawlor.
The introduction, in this year’s Finance Act, of a €5 million cap on the value of individual pension funds could have a significant negative impact on the ability of Small Self Administered Pension Schemes (SSAPS) to buy property as an investment asset. Indeed, the changes may well signal a slow death for SSAPS going forward.

Over recent years, and particularly with the introduction of a facility for pension schemes to borrow as part of their investment strategy, significant numbers of SSAPS have been established with the intention of buying property. For many, an added attraction was the prospect of transferring property into an Approved Retirement Fund (ARF) on retirement. The combination of the new €5 million cap, the cost of property ‑ particularly in Ireland ‑ ad the new ARF drawdown requirements may severely restrict such arrangements going forward.

Under the provisions of the Finance Act, the maximum value of all retirement benefits for any individual is capped at E5 million (unless the value already exceeds the E5 million on the Budget date of 7/12/2005 in which case the higher figure will apply). The value of the cap will be indexed going forward, in line with an ‘earnings index’. Assuming that the Scheme member will want to maximise the tax-free lump sum taken on retirement (25 per cent of the fund), this leaves a capital value of €3.75 million (again indexed). Whilst this may appear sufficient to buy a reasonable property, the calculation is not that simple, as the example below illustrates:

• Director aged 50
• Target retirement at age 60
• Assuming the €3.75 million is indexed at say 3 per cent p.a. this gives the cap of circa €5 million in 10 years time
• If you discount the €5 million back at say 7 per cent (an assumed property growth rate), it gives a current value of €2.5 million

Based on the Finance Act, the Minister has stated that the pension cap will be indexed in lie with an ‘earnings index’. We don’t yet know how this will work out in practice. But it is reasonable on investment grounds to expect that the property investment should grow at a faster pace than the ‘earnings index’. The figures above assume that the property asset grows in value at a rate 4 per cent p.a. in excess of the ‘earnings index’.

The net effect is that in reality one can probably only go to a level of circa €2.5 million in terms of a property acquisition. And in the Irish market of 2006, one cannot buy much for €2.5 million these days. One might buy a few apartments for this figure, but commercial property is hard to find at this level. And with the price of apartments (particularly in Dublin), issues such as value for money, potential capital appreciation, rental yields, market concentration etc need to be factored into the investment decision.

A further impact of the introduction of the cap will be that SSAPS seeking to buy individual property will now be concentrated in the €2.5 million and below sector. So we may have more funds fishing in a more concentrated and already overpriced market.

But what about overseas property? Well, yes these funds may be forced to look overseas ‑ UK and elsewhere. And this may for some be a possible solution. Certainly investment in UK property is not dissimilar to investing in Irish property ‑ similar legal structure, lower Stamp Duty, reasonably well understood market etc. However, buying property further a field may not be as simple. Issues may arise as to whether local tax structures will recognise a tax-exempt Pension Trust based in Ireland. It may be necessary to buy the property by establishing a company structure in the particular country (additional cost). And under Irish pension legislation one cannot invest in ‘holiday property’ abroad, even if this is intended to be purely for rental purposes.

So investing in an individual overseas property may not be that simple.

Even before the pension cap was introduced, anecdotally it was believed that many SSAPS were in fact ‘invested’ in cash, because they have struggled to find suitable individual property investments. Any SSAP in such a situation for say the last 12 months has effectively lost circa 16 per cent growth (in comparison to typical managed funds).

One solution which has become more popular is accessing property via a geared property syndicate. Typically this involves a promoter establishing a syndicate to acquire a ‘trophy’ building and funding such with 25 per cent equity and 75 per cent gearing (non-recourse to the investors). The equity will come from a range of investors (individuals and pension funds). Typically the property will be held for a period of 7 to 10 years, then sold and the value (net of outstanding borrowing) is returned to the investors. The advantage of this structure is that one can get access to better quality property, probably at better value for money, with less complication and with a higher level of ‘due diligence’ carried out by reputable promoters.

One further consequence of the changes introduced by the Finance Act 2006 is that members seeking to transfer an individual property (the 75 per cent of fund value) into an Approve Retirement Fund (ARF) will have to take account of the compulsory drawdown requirements. This requires all ARF holders to draw down at least three per cent of the ARF fund value each year from 2009 onwards, and to pay income tax on this amount. For a client invested in a single property, they will have to ensure that there is sufficient cash flow (rent) to cover this requirement and to cover any other costs associated with the property (e.g. insurance, repairs etc). If the sole asset of the ARF is a property then the individual could be forced to sell the property if in a particular year there was insufficient cash flow to meet the compulsory drawdown requirement.

The net result of the changes in this year’s Finance Act may well be that we will see a slow death of SSAPS, at least those seeking to invest in individual properties. For those SSAPS who already hold a property, they may need to review their plans in terms of what happens to the property when they retire. For SSAPS invested in cash but still seeking to find a suitable property, it may be time to face reality and adopt an alternative investment strategy. And for those thinking of establishing an SSAP with the intention of acquiring property… Well, I think it is time to think again.

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