Future of bricks and mortar pensions in doubt

'I've just bought a south-facing pension. Where's your pension? Dublin, Manchester, Chicago?" It may not be a typical dinner party conversation, but it is one that could become increasingly common among affluent business owners and company directors in search of a sexier approach to their retirement planning - just as long as the Government enacts an exemption to investment restrictions contained in a new EU directive.

Popular opinion has it that pensions are creaky, sleep-rendering things with invisible trustees and indecipherable documents, whereas property of all shapes and sizes is to be coveted and added to your investment shopping basket as often as your bank manager says you can afford it.

Since measures introduced in the 2004 Finance Act, however, property has become a "hook" to suck people into the traditionally sensible world of pensions.

That legislation gave the formal go ahead for borrowing within pension schemes, meaning holders of small self-administered pension schemes (SSAPs) could invest in property without first having to build up a fund of several hundred thousand euro.

All they need to do is wait until the pension fund has grown to the size of the required deposit, then "gear up". In other words, borrow the rest.

The appeal of the provision is that it effectively facilitates tax-free investment in property, subject to the currently generous annual tax relief limits on pension contributions. Last week hotel rooms became the latest property asset in which Irish investors can place their pension funds, with over 200 condominium units in Fitzpatrick's Hotel in Chicago put up for sale by retirement planning firm Finance Life, in association with Hibernian Life & Pensions.

A range of pension-backed property investment opportunities, both residential and commercial, is also available closer to home, with Canada Life, Irish Mortgage Corporation and the Prestige Group among those who have publicised Revenue-approved schemes.

But the future for new pensions-wrapped property deals hangs in the balance.

An EU directive on pensions due to be enforced in the Republic by September 23rd outlaws the practice of direct borrowing within pensions, effectively reversing the measures in the Finance Act.

Member states can exempt schemes of up to 100 members from the borrowing ban, but the Government here has yet to do it, failing to include the exemption in the Social Welfare and Pensions Act as had been expected.

After extensive industry lobbying, Minister for Social and Family Affairs Séamus Brennan set up a working group to investigate whether it should continue to permit borrowing by small schemes such as the one-person self-administered pensions that are used mostly by high net worth self-employed people and proprietary directors.

According to a spokeswoman for the Minister, the working group will finalise its report "within the next month".

In the meantime all schemes can borrow for investment purposes if the trustees of the scheme allow it.

"We have been told that the existing schemes won't have to rejig their position in line with the new regulations. They're not going to have to dispose of the assets and pay back the borrowings," says John O'Quigley, director of Deloitte Pensions and Investments.

In any case, it is now expected that the Government will now enact the exemption for smaller schemes, although the specific regulations governing borrowing have not yet been published.

"Séamus Brennan gave a speech in the Seanad that indicated that he didn't see why there should be any restrictions for one-person schemes.

"He didn't see any reason why they needed to be protected from themselves," says O'Quigley.

Gearing, or borrowing as it is more plainly known, automatically makes any investment riskier.

The returns generated by the property must exceed the interest rate paid on the borrowings for the investor to benefit from growth in their pension fund. The higher the borrowings and the more they are concentrated in a single property, the higher the risk.

"Certainly, I would advise prudence," says Joseph O'Dea, consultant at pensions firm Watson Wyatt and member of the Irish Association of Pension Fund (IAPF) investment committee.

"The more important this is to you in terms of your overall portfolio, then the greater level of diversity you should have. You should not be putting all of your money into a single geared property fund or a single asset," says O'Dea.

"Geared investments are always risky. If you start pouring money into property on a geared basis, it's quite possible that you would lose it all. You don't necessary want to run that chance with the money you are relying on for retirement."

On the other hand, if someone has a significant pension fund to play with, plus other assets that could act as their financial safety net for retirement, then a geared property scheme could be "an interesting investment", he adds.

Pensions-backed property schemes have high minimum commitments. For example, on the Finance Life Fitzpatrick's Hotel scheme, investors would need to cough up €100,000 upfront (to buy a hotel room worth about €203,000) and then an ongoing €1,000 a month.

"This is going to be substantial for most people," says O'Dea.

Some of the people who are attracted to geared schemes will be precisely those who don't have big funds built up.

"For people in their 40s who haven't been saving in a pension since they were 21, the ability to gear up on €100,000 and have an asset that is worth two or three times that is important. It can help bridge the gap," says Brian Culliton, financial consultant at the Prestige Group.

According to Eamonn McGrath, managing director of Finance Life, the majority of people want SSAPs for "one reason and one reason only - to invest in property".

One-person or two-person SSAPs, like all pension plans, must be approved by the Revenue Commissioners, and last year, when pressed by the lending institutions, the Revenue issued guidelines that limited loans to 15 years and ruled out interest-only loans and cross collateralisation.

These guidelines, however, will be replaced by new regulations once the ministerial order enacting the EU directive is signed.

But even if future borrowing by smaller schemes is permitted as expected, the EU directive contains another clause that might spoil the property party for SSAP investors, according to O'Quigley.

The predominant assets in the scheme must be traded on a regulated financial market. As investment in assets that are not traded on a regulated financial market must be kept to prudent levels, the new regulations may specify the maximum percentage of a fund that can be invested in an asset class such as property.

"We could have a situation where the schemes may be allowed to borrow but they might not want to because they won't be able to buy the property assets they want," says O'Quigley.

Nevertheless, he believes even without the ability to borrow, SSAPs offer freedom and choice to proprietary directors and other self-employed people.

"They can follow the specific investment strategy that suits their personality and transfer it into an approved retirement fund when they retire."