By Penny Bates
Private Client Tax Partner at Menzies Chartered Accountants
How else can I save for a pension and save tax too?
Penny Bates says closing the Sipp loophole hasn't fully closed the door
This question may have crossed the minds of quite a lot of people, who had been drooling at the thought of investing in a Sipp (Self Invested Personal Pension) and using it to buy a second home.
Now, the Chancellor's pre- Budget Report has effectively closed the door on investors placing residential property inside a Sipp.
The almost about face by the Chancellor has caused howls of outrage among financial advisers.
It has also left investors uncertain over future retirement plans that had been based on placing residential property, including holiday homes, into their pension plan.
There had been almost a media frenzy in the last 12 months over the tax opportunities to be had from the pension reforms coming into force on 6 April 2006 ("A-Day").
"A-Day" promises pension simplification.
For many investors that meant not only the chance for their Sipp to hold residential property, but for the first time, many other forms of investment not currently allowed, such as works of art, the odd racehorse or even fine wine.
So there are going to be a number of disgruntled investors who have already taken out Sipps in readiness for 'A Day'.
Where can investors go from here?
Commercial property will still be OK to hold within a Sipp and if held indirectly, residential property.
What does indirect ownership mean?
Well basically the Chancellor is promoting his new investments to be known as Real Estate Investment Trusts.
It will be possible for pension schemes to invest into these trusts and in that way to hold shares in property but not to buy property directly.
But most investors actually wanted to invest in residential property as it is often cheaper to buy than offices, shops or factories.
Often they feel they understand the residential market better.
What is the government trying to stop?
The government believes that people were planning to abuse the pension rules through investing in residential property; benefiting from the use of that property personally by, say, using it as a holiday home whilst also saving tax at the same time by placing it within the Sipp.
In fact, there had possibly been the prospect of an income tax charge on the use of the pension fund property or the need to pay rent for using it.
But this has been seen as acceptable in view of the tax advantages available by holding the property in the pension fund.
By now closing the door, it is estimated that the saving to the Revenue will exceed £3bn.
The government also seems to think that it is targeting only the very wealthy, but in my experience many more people were convinced of the benefits of placing residential property within the shelter of a pension scheme.
How does the new prohibition work?
If a Sipp still invests in a house or flat, tax will be charged to recoup all the tax relief on that property.
There are other penalties too. The various charges are complex, with part levied on the individual and part on the scheme administrators but they could all add up to tax charges of up to 70%!
Despite this, Sipps will still have their part to play in pension planning because the investor will continue to have control over the types of assets the scheme invests in.
The usual investments - stocks and shares, cash, commercial property etc - will still be available, giving a good spread for investment risk purposes.
Is there an alternative way to invest in property?
Yes. Let's say an individual still wishes to invest in property to provide an income for retirement.
This can be done separately from any formal pension arrangements.
And if the investment is made via a company there are still some valuable tax savings to be had.
Anyone can buy a company "off the shelf" and there are specialist formation agents who can do this for you, but specialist advice should be taken from an IFA or an accountant first.
While the property is let, the tax rate will be 19%, provided the profits are less than £300,000 and there are no associated companies.
Later on, the company will need to sell the property to realise cash with which to pay the investor a "pension".
The gain on the property will be taxed at 19%, provided the profit is less than £300,000.
This is likely to be the case for an individual with one investment property in their company.
So far the highest rate of tax paid is 19% - so not too bad, compared to holding the property individually (up to 40%) or through a pension scheme (up to 70%).
Once the property has been sold, the company would pay dividends each year to the investors.
If the investors are basic rate taxpayers with no other income, they could extract up to approximately £35,000 each with absolutely no tax liability for them or for the company.
Bingo, a tax efficient investment fund for the future.
Even better than a conventional pension scheme where the income is subject to the individual's tax rate - 22% or 40%.
There is no question that the chancellor has stopped what could have been a very interesting and valuable investment opportunity for pension funding.
There are, though, alternative routes at a fairly low tax cost that can deliver substantial tax savings.
The proposed rules offered a highly generous environment for pension savings and these changes mean that alternatives will need to be found.
There are other generous tax savings schemes available such as venture capital trusts and Isas, and individuals would be well advised to spend time talking through the options with their advisers.
The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.