No tax on contributions to your fund, no tax on rental income and no capital-gains tax if you sell: it isn’t hard to see why owning a property is seen as an attractive way to save for your retirement. But new European regulations have just made the process a lot more complicated, and potentially more expensive. It can still be done however, as we explain.
Why buy property with your pension?
If Irish people love their property, then they also certainly love buying it for their retirement funds. "It's a particularly Irish thing," says Tony Gilhawley, founder and principal of Technical Guidance, of the desire to invest in property.
Although there are no figures on the scale of property investment for pensions, providers say it is a popular choice, particularly for those who have their own occupational scheme, known as a small self-administered scheme, or SSAS. "Property became very attractive in SSASs, as you can use the rent to draw down income," says Glenn Gaughran, head of business development and marketing with Independent Trustee Company.
And the advantages are clear. You benefit not only from the potential for capital growth but also from rental income, which is allowed to grow tax free. And if you sell the property, any gains are distributed free of capital-gains tax back into the fund.
Social-housing investment has also become particularly popular among such pension funds in recent years, as investors can buy a property through their pension fund, which must be done at arm’s length, and negotiate an agreement with a local authority to lease the property at guaranteed rents for up to 25 years.
And with rents so high, yields can be particularly attractive. According to Daft.ie’s rent report, two-bed properties in Dublin 17 are currently yielding 10.4 per cent, while you can get a 13 per cent yield on a one-bed in Roscommon and 9.6 per cent on a two-bed in Limerick city.
Until recently, SSASs could invest 100 per cent of their assets in property, and could borrow to do so. But this meant property lovers risked not being adequately diversified. And, as we all know, property prices sometimes don’t just fall but plummet, which may put pension savers’ retirement funds at risk.
Buy a property with your pension?
Investment yields you can currently expect
Dublin 2 Two-bed house 5.4 per cent
Dublin 4 Four-bed house 2.9 per cent
Dublin 17 Two-bed house 10.4 per cent
Cork city One-bed apartment 10 per cent
Galway city Two-bed house 8.2 per cent
Limerick city Four-bed house 4.9 per cent
Roscommon One-bed apartment 13.1 per cent
Source: Daft.ie
What has happened?
To counter this lack of diversification, and offer greater protection to pension savers, the EU recently introduced new rules. Its directive on institutions for occupational retirement provision, known as Iorp II, which was transposed in Ireland in April 2021, is all about ensuring that occupational pension schemes are sound and better protect members and beneficiaries. The rules themselves are not new; they were first introduced in 2006, but single-member schemes such as SSASs were exempt. Now, however, they are included, as there is no derogation for such schemes this time around.
The changes
So what does Iorp II mean? In short, there is now an effective ban on borrowing in a SSAS, and investments in unregulated products, such as property, loan notes and renewable energy, cannot exceed 50 per cent of the value of an SSAS.
It’s not a ban on direct property investment. As Gilhawley notes, “There is a misconception that you can’t invest in property, but that’s not true”. It will, however, make the process more complicated. As a result, some have argued that a derogation should have again been granted to SSASs and that pension savers should have more control over their investments.
Gilhawley disagrees. “I would say that’s absolutely fine if that was your own money, that the State shouldn’t be telling you where to invest it. But it’s not your own money: half the money is tax relief provided by the State,” he says, noting also that the move to better diversification is a good thing, and that if the rules had been in place back in 2009-11, then many people who saw their pension savings wiped out would have retained at least half of them.
“It is a feature of part of the SSAS market – and it is only part – that some SSASs invest only in geared property and/or loan notes apart from holding a small amount of cash, and this is a very high-risk approach to take,” he says. “It’s the people with SSAS who want to put everything into property. These are the people with the problem, you can’t bet it all on one asset.”
There is also the question of whether it is fair to give one group of people tax relief to buy property, so they’re buying it on a gross basis, while first-time buyers have to purchase it out of their net, or after-tax, income even though they may be competing for the same property.
The rules also apply to other occupational schemes, so it may make sense that they should apply to all.
I’ve already invested in property. Am I affected?
If you have already established an SSAS, and it has invested in property, then you don’t need to be too concerned with the new legislation, because, as Gaughran notes, existing investments are not affected.
But you may still be impacted when it comes to new investments. Let’s say you have an existing SSAS, worth €1 million, of which only 10 per cent is in unregulated investments. You may think that buying a property tomorrow, worth €150,000, will be allowed, as your fund will still have less than 50 per cent in property. It is not yet clear, however, whether the 50 per cent rule applies to the entire fund or to new contributions. “It remains to be seen how the practical application of this will work,” says Gilhawley.
Can I still invest in a property?
It will still be possible to invest directly in a pension fund – perhaps just more difficult to do so. “It is more complicated, but there are work-arounds,” says Gaughran. If you’re a new investor, for example, establishing an SSAS after April 27th, 2021, you must have less than 50 per cent of your total fund in property or risk being fined.
And the reality is, given the potential growth in the value of the unregulated investments, that it’s likely to be significantly less than this to make the numbers work. “Trustees are going to have to take a lower amount than 50 per cent so it doesn’t breach” the limit, says Gaughran. The Davy stockbroking firm, for example, is understood to have introduced a limit of 20 per cent of the fund in unregulated investments.
In reality, then, if you want to fund a €150,000 property purchase, you may need to have about €750,000 in total in your pension fund. As Gaughran notes, this will make buying a property in your 30s or 40s more difficult, as your fund may not have enough assets to meet the diversification ratio.
There are other ways around it, however, as both buy-out bonds,or BOBs, and personal retirement savings accounts, aka PRSAs, are excluded from the legislation. This means you can buy property through these vehicles.
What’s wrong with a BOB or PRSA?
Well, then, you might say, I’ll just set up a BOB or PRSA to fund my property purchases. But it’s not just as simple as that. First, this is because the funding opportunities via an SSAS are better than under a PRSA, where contributions are bound by rules about age and percentage of salary that can benefit from tax relief; benefit in kind, or BIK, also applies in a PRSA. “An occupational scheme is still the most suitable to get tax-efficient contributions,” says Gaughran.
Okay, you say, I’ll keep the SSAS for new contributions and hive off the property purchases and other unregulated investments into a BOB or PRSA. Unfortunately, this isn’t possible, as, according to Gaughran, you can’t transfer some of the assets out of an SSAS. Instead, you have to effectively close the SSAS and move the assets into a BOB. “With occupational schemes you can’t partially transfer out of it. It’s either all or nothing,” he says.
And a challenge then is that a BOB is closed to new contributions. “It’s not an active scheme. It’s basically a preserved scheme,” says Gaughran.
What might be possible is to close the SSAS, set up a BOB for the investments you want to make, then establish a new SSAS for contributions going forward. But, as Gaughran notes, this can be expensive and cumbersome. “Operating two schemes is inconvenient and could be expensive,” he says.
Finally, although a BOB has a similar charging structure to an SSAS, the charges on a PRSA will be higher. According to Gaughran, annual charges on an SSAS are typically about 0.5 per cent; on a nonstandard PRSA they can be 1.25 per cent.
Can I still borrow?
As BOBs and PRSAs are outside the scope of Iorp II, you can still borrow through these vehicles. ICS Mortgages, for example, says it will no longer lend to SSASs directly; instead it will lend to them via exempt unit trusts at up to 50 per cent of the value of the property, at a variable rate of 4.25 per cent. Loans range from €40,000 to €500,000, for a maximum 15-year term.
Still unclear?
Some finer points about the new legislation are still unclear. The Pensions Authority is due to give further guidance with the publication of a draft code of practice, which will then be open to consultation, to be published around July 19th. This will be followed by a final code of practice set to be published around November, 15th, 2021.
