SIPPs Why all the fuss

While self investment pension plans ('SIPPs') have been around since 1989, they have been attracting a huge amount of attention over the last 12 months. The SIPPs hype started when plans were announced in last year's budget to widen the scope of investments that SIPPs could purchase. These new investments included a variety of sexier asset classes such as fine wines, fast cars, art and, most importantly, direct investment in residential property, both at home and abroad.

The tax advantages that these changes offered to high net worth individuals were vast. Theses changes were to take effect on the 6th of April 2006, which has since become known as A day.

SIPPs were created to address the two main pension problems. Traditional pensions offer limited flexibility when it comes to managing how you invest your contributions. Your average insurance company personal pension or stakeholder plan will typically offer a range of between 20 to 30 investment funds, with the more adventurous companies offering up to 70 funds. By comparison a typical SIPP will give you the freedom to choose from a selection of around 1,000 funds, including those managed by the leading fund management groups. In addition you can use a SIPP to invest directly in individual equities of your choice, gilts, bonds and commercial property.

Prior to Chancellor Gordon Brown's recent pre-budget speech, you were also able to invest directly in residential property in the UK or overseas.

The second major issue addressed by SIPPs is that once retirement age is reached you are not forced to purchase an annuity. Annuities are very inflexible and poor value for money if the purchaser dies early.
After A Day 25% tax free cash can be withdrawn from a SIPP. An annuity need never be purchased, even at age 75. SIPPs allow you the flexibility to determine at any stage how much income you take from your pension. SIPPs can be left to family in the event of death and if an individual dies before the age of 75, inheritance tax is charged at 30% as opposed to 40% for regular pension plans.

SIPPs became the focus of attention predominantly due to the fact that they would be allowed to purchase residential property as part of their investment portfolio. It was also stated that individuals would be able to transfer properties that they already owned into their SIPPs and realise significant tax advantages by doing so. The tax advantages that this situation presented was based on the fact that an investment in the SIPP attracted tax relief of up to 40% for individuals paying tax at the highest marginal rate. Thus properties purchased by SIPPs could be bought with pre tax as opposed to after tax income.

The new rules also had real estate agents drooling over the impact that SIPPs would have on their property sales. Some large insurers have reported that they have been approached by thousands of agents trying to get their services pushed. Many SIPPs experts agree that a large number of these agents have been mis-selling SIPPS to the public to line their own pockets and cautioned individuals to consult their financial advisors prior to purchasing property through a SIPP.

What's changed?

In the Chancellor's recent 2006 pre-budget speech it was announced that SIPPs would no longer be allowed to invest directly in residential property. The announcement was met with outrage by the financial sector who felt that the Chancellors U turn at such a late stage was ridiculous. The Chancellor also shut the door on many of the other new forms of investment such as works of art, classic cars and fine wines. Many investors have been left doubtful about their retirement plans that were reliant on residential property being placed into their SIPPs.

The new SIPP rules were widely regarded as a tax break for wealthy individuals considering the huge tax advantages that were possible when buying second homes. The new changes came about as the government believed that people were planning to abuse the rules by benefiting from the use of a property as well as saving on tax by holding the property in a SIPP. It is estimated that over £3 billion would have flowed out of the governments coffers had the rules not been changed.

A treasury spokesperson stated that the change in policy was 'a proportionate response to an unintended consequence of simplification.'

The new prohibition on SIPPs investing directly in residential property states that tax will be charged to recoup any tax relief on the property purchased. Complex penalties have also been introduced that could see tax charges on residential properties purchased by SIPPs reach as high as 70%. The government has also placed a ban on SIPPs setting up companies to purchase residential property, as the substance of this type of scheme is the same as the SIPP owning the property directly.

What now?

Not all is lost though. SIPPs will still be able to invest in residential property through Real Estate Investment Trusts (REITs). This is a new type of investment being promoted by the Chancellor. REITs will be introduced in the UK in 2006 and will take the form of a quoted company on the stock exchange. A REIT will not be liable for tax on its profits, instead, provided it distributes 95% of its net income to its shareholders, who will pay tax on their receipts, the company itself will be exempt.

REITs will give investors more access to property without the risks of direct ownership. This is because it is impossible for the smaller investor to buy a diversified portfolio of residential property with the limited lending capabilities of SIPPs. SIPPs are only able to secure loans up to 50% of the value of the fund. Individuals will be able to start investing in REITs from as little as £10,000 and be able to get exposure to a much wider variety of residential property markets. Further, REITs purchased by SIPPs will attract tax relief.

The Chancellors ban on residential property ownership by SIPPs certainly seems to have dampened interest in these pension schemes but SIPPs do still offer investors valuable flexibility in planning for their retirement. The introduction of REITs gives investors significant tax advantages and a much safer way to invest in residential property.

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