The landscape of pension investment and property ownership has evolved significantly, with many trustees and pension holders now managing commercial rental portfolios within their pension arrangements.
As Making Tax Digital continues to expand across the UK tax system, a pressing question emerges: Do pension funds with rental property face MTD obligations?
This article examines the current position, explores the key pension planning rules and provides practical guidance for those holding or considering rental property within pension funds.
Current MTD Position for Pension Funds with Rental Property
Making Tax Digital for Income Tax (MTD for ITSA) introduces major changes to how individuals must keep records and report income.
From 6 April 2026, sole traders, landlords, and other individuals with qualifying income above £50,000 will need to:
Keep digital records using HMRC-approved software.
Submit quarterly updates to HMRC.
The income threshold will then reduce to £30,000 from 6 April 2027 and further to £20,000 from 6 April 2028.
In contrast, registered pension funds are generally not subject to MTD for ITSA. Under the Finance Act 2004, rental income earned by registered pension schemes is exempt from income tax, provided the scheme remains within the approved regulatory framework.
Since these schemes do not pay tax on rental income in the ordinary course, they are outside the scope of MTD.
This means that a pension fund holding rental property:
Does not need to maintain digital records
Does not need to register for MTD
Does not need to use MTD-compatible software
Does not need to submit quarterly updates, regardless of the size of the portfolio or level of income.
What is the Tax Treatment for Pension Funds with Rental Property?
Registered pension schemes enjoy extensive tax exemptions under Part 4 of the Finance Act 2004, which encourage long-term retirement savings by shielding most types of income and gains within the fund from tax.
Under section 186 of the Finance Act 2004, rental income from investments held for pension purposes is exempt from income tax, meaning property income within the fund does not need to be reported to HMRC.
Likewise, section 271 of the Taxation of Chargeable Gains Act 1992 exempts capital gains arising from the sale of pension fund assets, including property, from capital gains tax (CGT).
These exemptions apply to both occupational pension schemes and self-invested personal pensions (SIPPs) and cover residential and commercial property held as genuine pension investments within the regulatory framework.
Furthermore, if the pension fund engages in property trading or business activities, rather than holding property purely as an investment, the resulting income may be treated as taxable trading income, removing the exemption.
Exceptional Circumstances Where Tax Charges Might Arise on Pension Funds with Rental Property
While registered pension funds are generally exempt from tax on rental income, there are certain exceptions where tax charges may arise.
First Exception
The first exception involves unauthorised payments. These occur when a pension scheme makes a payment or provides a benefit that does not comply with the rules under the Finance Act 2004.
In such cases, the member faces unauthorised payments charge of 40%, which increases to 55% if unauthorised payments exceed 25% of the fund’s value in a tax year (due to an additional 15% surcharge).
The scheme administrator is also subject to a 40% scheme sanction charge, typically reduced to 15% when the member has paid their charge.
Unauthorised payments may arise where, for instance, a residential property owned by the fund is occupied by a member or connected party, triggering both tax liabilities and regulatory breaches.
Second exception
Arises where the pension fund engages in trading or business activities involving property.
Pension schemes are expected to act as passive investors rather than active traders. If the fund undertakes property development or dealing on a scale that constitutes a trade, HMRC may treat the resulting profits as taxable trading income, removing the usual exemptions.
Occasional sales or refurbishments for long-term investment purposes are unlikely to be treated as trading, but systematic property development aimed at generating short-term profit may cross that line.
Third exception
Involves overseas property. Although rental income from overseas property is typically exempt within a registered pension scheme, some foreign jurisdictions impose withholding or local taxes that cannot always be reclaimed. These represent a real cost to the fund, even though the income remains exempt from UK tax.
In practice, these exceptions are rare, and most pension funds with rental property operate well within the tax-exempt framework. However, advisers should remain vigilant, particularly where funds hold residential property with potential connections to members or engage in active property management that might resemble a trade.
Trust Exemption as Additional Protection for Pension Funds with Rental Property
Many pension schemes are set up as trusts, with trustees holding assets on behalf of members. This structure provides clarity and protection regarding the tax treatment of rental income.
While trusts are generally subject to income tax, registered pension schemes are specifically exempt under section 186 of the Finance Act 2004. This applies regardless of whether the scheme is a trust, insurance contract, or another arrangement. Importantly, the exemption applies to the scheme itself, not the trustees personally, so rental income within the trust remains tax-exempt.
Trustee Responsibilities
The trust structure also imposes fiduciary duties on trustees. They must act in the best interests of members, ensuring that property investments are appropriate, properly managed, and compliant with scheme rules.
From a tax perspective, the trust structure separates the fund from individual members, keeping rental income within the fund for reinvestment and maintaining its tax-exempt status.
What Is the 70% Rule of Pension?
The 70% rule is a commonly used guideline in pension planning, suggesting that retirees may need around 70% of their pre-retirement income to maintain their standard of living. The figure is not fixed and varies depending on individual circumstances, such as outstanding financial commitments or lifestyle expectations.
Financial advisers often use it to calculate the level of pension contributions needed during working life.
For pension funds with rental property, the 70% rule is indirectly relevant. Rental income can provide a steady income stream to supplement pensions, helping to achieve the target retirement income.
Trustees and members should assess whether property rental income, considering rental yields, management costs, and potential capital growth, will meaningfully contribute toward meeting retirement needs.
What Is the 4% Rule on Pension?
The 4% rule is a guideline for sustainable pension withdrawals, suggesting retirees can withdraw 4% of their pension pot annually, adjusted for inflation, with a reasonable expectation that funds will last 30 years.
Originating from research by William Bengen in the 1990s, it assumes a balanced portfolio and stable returns, but in practice, factors like market fluctuations, longer life expectancy, and early retirement spending can affect sustainability.
Some analysts now recommend lower rates, around 3–3.7%, under current market conditions.
For pension funds with rental property, the 4% rule can guide withdrawals by combining rental income and other pension assets to support sustainable income. While property can provide both income and capital growth, its illiquidity, potential void periods, and maintenance costs must be considered when applying the rule.
What Is the 2% Rule on Pension?
The 2% rule is a more conservative pension drawdown guideline, recommending retirees withdraw 2% of their pension pot annually to preserve capital and reduce the risk of running out of money.
It is suited for those retiring early, expecting long lifespans, concerned about market volatility, or wishing to leave an inheritance.
Applying the 2% Rule to Pension Funds with Rental Property
For pension funds holding rental property, the 2% rule promotes a cautious approach to withdrawals. Rather than drawing heavily from the fund, rental income can be used to support ongoing withdrawals while preserving the capital value of the property.
This approach may involve:
Reinvesting rental income back into the fund,
Maintaining property value through proper upkeep, and
Avoiding excessive withdrawals during periods of low rental yields or property market downturns
While the 2% rule is not a mandatory requirement, it serves as a useful benchmark for balancing current income needs with long-term financial security, helping trustees and members protect retirement funds and sustain income over time.
Can I Have a Rental Property and Still Get a Pension?
It is entirely possible to own rental property and receive a pension, as rental income does not affect entitlement to state, workplace, or personal pensions, though it may impact means-tested benefits or tax liabilities.
Holding Property Within a Pension Fund
Registered pension schemes, including SIPPs, can hold both commercial and residential property as investments. Rental income and capital gains from these properties are generally exempt from income tax and capital gains tax, making property an attractive option for long-term pension savings.
Important Restrictions
There are, however, critical restrictions to be aware of:
Residential property occupied by the member or connected parties is prohibited
Commercial property can be held more flexibly and may even be leased to a member’s business, provided arrangements are at arm’s length
Compliance with these rules is essential, as breaches can trigger tax charges and penalties.
Upcoming Changes to Inheritance Tax
From 6 April 2027, unused pension pots, including property held within them, will be included in the inheritance tax (IHT) estate. This means such property could be subject to 40% IHT above the nil rate band, representing a significant change in estate planning considerations for pension funds with rental property.
Careful planning and professional advice will be necessary to navigate these changes and ensure tax-efficient outcomes for pension beneficiaries.
Practical Steps for Managing Pension Funds with Rental Property
For trustees and administrators of pension funds with rental property, key practical steps include:
Confirm HMRC Registration: Ensure the pension scheme remains registered with HMRC. Registration is essential to maintain tax exemptions on rental income and capital gains.
Comply with Property Restrictions: Avoid holding residential property occupied by members or connected parties and ensure all property investments comply with regulatory rules.
Keep Accurate Records: Maintain clear records of rental income, expenses, and property valuations. Even though pension funds are not subject to MTD, proper record-keeping supports regulatory compliance and financial reporting.
Regular Portfolio Reviews: Regularly assess the property portfolio to ensure it aligns with the fund’s objectives and generates sufficient income and growth to meet members’ retirement needs.
Manage Liquidity: Property is relatively illiquid. Hold other assets to cover short-term cash flow needs and plan for potential inheritance tax liabilities from April 2027.
Maintain Property Management Arrangements: Ensure management is cost-effective, arm’s length, and does not provide unauthorised benefits to members.
Review Estate Planning: Update expressions of wish and consider alternative structures considering upcoming inheritance tax changes to protect members and beneficiaries.
Seek Professional Advice: Complex transactions, such as property development, overseas investments, or dealings with connected parties, should be reviewed by specialists to ensure compliance and minimise risk.
What are the Penalties and Compliance Risk for Pension Funds with Rental Property?
While pension funds with rental property are generally exempt from Making Tax Digital (MTD), they must still comply with pensions legislation and broader tax obligations. The most serious risk comes from unauthorised payments, where members can face charges of 40–55% and scheme administrators up to 40%, reduced if the member pays their charge. For example, this can occur if a member or connected party occupies residential property without paying commercial rent.
Key compliance requirements:
Reporting: Submit annual returns and event reports to HMRC; penalties start at £400 for late filings.
Regulatory oversight: The Pensions Regulator can impose fines, improvement notices, or wind-up schemes for governance failures.
Registration: Losing registered status can render rental income and gains taxable, potentially bringing the fund within MTD scope, though this is uncommon.
Best practices for trustees and administrators:
Maintain strong governance and clear decision-making procedures.
Conduct regular reviews of property investments to ensure alignment with fund objectives.
Seek professional advice on complex transactions, including property development, overseas property, or dealings with connected parties.
Keep accurate records and ensure timely reporting to HMRC and regulators.
Following these steps helps pension funds with rental property remain compliant, tax-efficient, and well-governed, while minimising the risk of penalties or regulatory action.
Conclusion
Pension funds with rental property enjoy broad income and capital gains tax exemptions under the Finance Act 2004, provided they remain registered and operate within regulatory rules. They are not subject to Making Tax Digital (MTD for ITSA), so there is no obligation to register, keep digital records, or submit quarterly updates.
However, funds must remain aware of tax risks, including unauthorised payments, trading activities, and overseas tax liabilities, and trustees have fiduciary duties to manage investments in the best interests of members.
A major upcoming change is the inclusion of unused pension pots in inheritance tax (IHT) estates from 6 April 2027, meaning property within pension funds may face 40% IHT on death, requiring careful estate planning.
Trustees and administrators should therefore focus on accurate record-keeping, compliance with pensions legislation, regular portfolio reviews, and proactive estate planning to ensure tax-efficient outcomes for members and beneficiaries, even though MTD does not apply.
FAQs
No. Registered pension funds and schemes are exempt from MTD. The rules mainly apply to individual landlords and self-employed people with rental income above the threshold.
Unincorporated landlords with annual rental income over £50,000 (from April 2026) must comply. The threshold drops to £30,000 from April 2027.
No. Rental income held in a pension fund doesn’t count toward an individual’s MTD threshold.
Yes. Registered pension schemes, non-resident companies, and certain trusts or estates may be exempt.
Yes. Trustees can appoint accountants or agents to manage MTD submissions using approved software.