Ian Martin, financial planner in our corporate division, on how we helped three directors buy an office for their business without a bank loan or mortgage while also boosting their pension savings.
Steve, 40, Sarah, 42, and Derek, 47 set up their consultancy specialising in out-sourced IT for small and medium-sized businesses four years ago. They rented a small office and business was going reasonably well and they took on an admin person and a junior consultant. Then COVID hit – and demand for their services surged as businesses needed to get good, secure systems set up for employees working from home.
They have taken on more employees and now need a larger office – staff are encouraged to be office-based when not working at a client’s site, as they feel that this creates a better team spirit and better communications. With office space plentiful and relatively cheap, they decided to buy and approached their bank, which would lend them money but at 11%, which they considered to be an unreasonably high interest rate. The bank also wanted personal guarantees from the directors. They were not keen on this so asked their accountant whether the business could sustain such high repayments and whether there were other options, such as remortgaging their respective homes. Their accountant recommended that they talk to MKC WEalth, as we have been working with the three-partner accountancy practice for a few years, setting up and running workplace pensions and employee benefits schemes, and helping clients structure and protect their business and personal finances efficiently.
Around £600,000 in self-invested pensions
I went to meet Steve, Sarah and Derek in their office. I explained that they may be able to raise the money between them and asked them about their personal financial circumstances: mortgages and borrowings, total household income, pensions and other savings. Before setting up the consultancy they had worked for one of the large IT consultancies and had accrued reasonable amounts in their pensions. They had each set up a self-invested pension, (SIPP) and had continued paying in to these once they set up the consultancy. Between them they had around £600,000 in them.
They told me that they had narrowed the search for the office down to two options, one costing £580,000 and the other £630,000. They were keen to move quickly, as they felt the prices were good and therefore the properties likely to sell quickly. I explained that they could use money in their SIPPs to buy the property, which the SIPP could then rent to the business at a fair market rent. Each SIPP would own a percentage of the property proportionate to the amount each had contributed. The rental income would be apportioned according to the same percentages. Fortunately, the SIPPs they had set up allowed property to be held within them – which is not the case for all SIPPs.
Rental income paid into the SIPPs
They liked the idea that the business would pay rent into each of their SIPPs, instead of paying interest to a bank that had lent it money. Although they realised that the values of their SIPPs would remain roughly the same and would fluctuate in line with commercial property values rather than investment funds values, they were concerned that most of the value of their SIPPs would be in a single asset, the office. They were reassured when I explained that the rent counts as income for the SIPP, so doesn’t reduce the amount that can be paid in as contributions each year. I suggested that, as the business is doing well, it pays in the maximum employer contributions each year. If £60,000 a year (the new maximum annual contribution limit) is paid in each year, they will soon build up a good-sized amount that can be held across a diverse portfolio of investment funds which would have the opportunity to grow over the years before any of them will access their pension. I also pointed out that if for whatever reason the business moved out of the office, they could sell it, with the funds being paid in to their SIPPs pro rata, or find a new tenant, in which case their SIPPs would continue to receive rental income.
They decided to go ahead and buy the cheaper property for £580,000. I arranged for the legal framework of the property purchase be drawn up and recommended that they take out insurance so that should one of them die unexpectedly there would be no financial impact on the other two.
Tax-efficient reorganisation of salaries, dividends and pension contributions
Finally, their accountant and I worked out the most tax-efficient remuneration split between dividends and salary and a similarly efficient split between employer and employee pension contributions. Pension contributions should, I recommended, be paid in monthly, to take advantage of what is known as pound-cost averaging – the idea is that by paying in a small amount each month sometimes you are buying in at a lower price and other times at a higher price but over time you will end up paying roughly the average price. It also gets more of your money invested faster.
Steve, Sarah and Derek and their staff moved into the new office three months later. The trio are now confident that their business is on a stable footing to continue its expansion and that their personal financial planning is more tax-efficient.
Please note that although this story is based on real clients, we have changed their name and aspects of their personal information to protect their privacy and identity.
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