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Finally, Vanguard SIPP pension arrives in the UK!

First Published: March 2020 | Available in: Property Articles Your Property Network

By specialist property accountant Stephen Fay ACA

Many landlords are of course keen to invest mostly in property, but many are also attracted to the tax relief that pensions offer, and to help with Section 24 tax mitigation, but may be worried about what the pension is actually invested in, and about high pension fund charges. A huge pension fund in the USA, Vanguard, has announced it will offer UK SIPP pensions from early 2020 – Vanguard is famous for its ultra-low charges and its simplified approach to pension investing – this is a big deal for UK pension investors as Vanguard has $5 TRILLION of assets under management – yet few UK investors have heard of them, until now …

This article looks at why pension investing should be part of most landlords financial planning, and in particular what sets Vanguard apart as a pension fund option. Note: this article isn’t intended to cover every aspect of pension investing – just the principle benefits of pension investing and highlight Vanguard as a new option for 2020 onwards.

Remind me, why should I consider investing in a pension? I’m a landlord and property gives great returns and is easy to understand, so why should I invest in something I don’t understand?

Investing in a pension complements investing in property – it’s not one or the other. The general benefits of pension investing are:

  • Generous (often 40%) tax relief on pension contributions (compared to no tax relief when buying property assets)
  • Pension fund income and capital growth is tax-free within the pension – allowing compound growth with no tax to reduce growth
  • Generous per-person lifetime pension allowance (March 2020: £1,055,000)
  • Option to take 25% as tax-free lump sum at age 55 (57 from 2028) – remainder to be drawn off ideally as a Basic Rate taxpayer to minimise tax on income withdrawn
  • Option to pass on the pension to beneficiaries, potentially tax-free (so, very Inheritance Tax efficient way to pass on assets)

How can property investors invest tax-efficiently in a pension? How does this help with “Section 24” mortgage interest relief restrictions?

A SIPP pension can accept both personal and company contributions:

Personal contributions:

  • Landlord with no PAYE income -> maximum pension contribution is £2,880 “net”, on which the SIPP recovers £720 (25%) to make £3,600 “gross”
  • Landlord WITH PAYE income -> maximum pension contribution is the PAYE income itself

Note: for personal pension contributions, the gross pension contribution extends the Basic Rate (20%) income tax band i.e. allows the person to earn more income and just pay 20% income tax rather than 40% e.g. making a £2,880 cash (net) pension contribution helps with Section 24 exposure by increasing the Basic Rate band from £50,000 to £53,600 (so, potentially an extra £7,200 of property income for a couple is NOT subject to Higher Rate income tax as a result)

Company contributions:

  • Many landlords now have a property company, which may earn its own rental income from properties it owns, and / or may charge property management fees (often to the director’s own personally-help properties).
  • Up to £40k per year of pension contributions can be made, which simply reduces the company’s tax bill (e.g. a company making a £40k pre-tax profit but making a £40k pension contribution pre-year-end would pay no tax at all, compared to £7,600 if the pension contribution was NOT made).

Many landlords with company and personal-owned properties choose to live off the personal rental profits, and invest the company’s profits into their pension – if the personal income is sufficient for their day-to-day income needs.

Who is Vanguard and what’s so special about this pension fund?

Vanguard was founded around 45 years ago in the USA, by Jack Bogle, and is famous for being owned by its own funds. This means that Vanguard is owned by its own investors – there are no outside shareholders to pay dividends to – so, Vanguard can focus solely on maximising performance and keeping costs low (unlike other pension funds where the fund managers cream off large fees and commissions!). Vanguard already offers UK ISAs and Junior ISAs, but is about to launch its first UK pension.

Essentially, Vanguard invented the pension ‘index fund” offering incredibly low fees compared to other pension funds – and, Vanguard is now a pension behemoth, with over $5 TRILLION of assets under management, making it the largest index-fund in the world – yet, in the UK, Vanguard is relatively unheard of!

“Don’t look for the needle in the haystack – just buy the haystack!” – Jack Bogle

Vanguard’s investment philosophy is to keep things simple and keep charges low. Vanguard’s mission in 1970s America was to bring pension investing to the masses, via the creation of the “index fund” – an “index fund” tracks an entire market, rather than picking individual shares and bonds to invest in.

The idea is that steady investing into the entire market, along with ultra-low fees, would enable the ‘man on the street’ to become wealthy. Vanguard’s view is that regular investing in the “right” (depending on your risk profile) mix of shares and bonds, along with ultra-low charges, is most investor’s best option to maximise long-term returns – and, don’t tinker with the plan by allowing emotions to get the better of you as returns fluctuate from one year to another!

But what does the pension itself invest in?

Vanguard offers lots of investment options, however the “LifeStrategy” funds are very popular because they offer an easy-to-understand-way for investors to choose the level of risk they want to take. The funds are well-diversified in terms of regions (UK, USA, Asia etc) and company type (consumer goods, tech, oil & gas etc) as the fund is a passive index-tracker. The LifeStrategy funds hold 6,000 to 20,000 shares and bonds around the world, to reduce risk.

Shares generally offer a better return over the long term than bonds, but the returns are more volatile – so the LifeStrategy funds allow you to pick the % of shares you want to invest i.e.

LifeStrategy 100% Equity fund = 100% shares, 0% bonds

LifeStrategy 80% Equity fund = 80% shares, 20% bonds

…and there are 3 further LifeStrategy funds with a 60% / 40% / 20% share investment (the remainder being bonds) – so a portfolio approach to suit everyone’s risk appetite.

Vanguard also offers many other types of index and equity funds, and of course professional advice should be sought if required. However the Life-Strategy funds offer a simple, balanced, easy to understand option that many investors consider to be the bedrock of their non-property investments (perhaps complemented by some more volatile / risky investments but with the Vanguard fund considered to be the safe and solid base).

Fees and charges – the Vanguard “Unique Selling Point”!

Make no mistake – the arrival of the Vanguard SIPP in the UK will disrupt the UK pension industry. The Vanguard ‘account fee’ is just 0.15% per year, with no fee above £250k of assets (so, maximum annual fee = £375). This is an incredibly low charge given that many funds charge 2-3% per annum (which in many cases can equal the investment return!). There are also (as with all pensions) ‘fund charges’, however these are again incredibly low at typically between 0.06% – 0.78%.

Don’t forget the “power of compounding” – high charges and fees levied by pension managers act as a major drag on returns over the long term – compounding can work for or against you in the world of investing!

Vanguard’s website is as follows: https://www.vanguardinvestor.co.uk

A note about timing of pension contributions…

Generally it’s better to drip-feed pension contributions to avoid the risk of buying-in at the top of a peak. So, perhaps think about a quarterly pension contribution, to allow the peaks and troughs of equity investing to smooth – the Americans call this “dollar cost averaging”, and it’s basic investment strategy, perfectly in agreement with the Vanguard model of regular saving into a diversified, cheap, index fund.

Later-life tax planning with pensions

Apart from the Section 24 tax-mitigation benefits of making pension contributions, and the tax-free income & capital growth as the pension values builds over the years (accelerated by the low fees charged by the pension fund hopefully!), the other key benefit of a pension is the option to pass on the entire pension (around £1m per person) to a beneficiary completely free of tax – unlike property (sadly!), pensions are very Inheritance tax-efficient.

Many older landlords therefore choose to spend their personal rental income, but invest into their pension as a mix of personal & company pension contributions, to build up the pension (up to £2.1m for a couple!) to gift to family.

And, at the same time, gradually sell off personally-held properties in later-life to make use of CGT exemptions, and use the regular (annual, typically) proceeds from property sales to supplement property income, and then die with a net estate (gross assets less liabilities EXCLUDING pension) of £1m for a couple, on which no IHT would be paid.

Along with potentially £2m of pension assets, this could mean around £3m could be gifted to family with no IHT payable – and, no expensive trusts or IHT-planning needed either i.e. the pensions essentially act as a trust would do – an on-shore, simple way to transfer £1m per person to the next generation, in addition to the £1m IHT 0% band (including personal home equity).

Conclusion

Many landlords have in recent years – especially since the 2015 announcement of “Section 24” mortgage interest relief restrictions – started to appreciate that they are missing a trick by ignoring the financial benefits of pension investing.

Investing in personal and company name (some planning needed to ensure the optimum mix) can produce some useful tax savings – but, what then, once the funds are in the pension?

Investing in personal and company name (some planning needed to ensure the optimum mix) can produce some useful tax savings – but, what then, once the funds are in the pension?

Vanguard offer what many landlords want – simple investment options, ultra-cheap fees, great online account & customer service – it’s taken a long time for Vanguard to reach the UK, but rest assured Vanguard will be a major ‘disruptor’ to the UK pension industry over the next few years (you read it in YPN first, of course!).

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