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17 min read 5 Apr 22
Buy to let property, as well as pensions, continue to be popular investment vehicles for retirement planning. We look at the advantages and disadvantages of each.
Pensions and the purchase of buy-to-let property continue to be popular investment vehicles for retirement planning resulting in the age old discussion – ‘should I invest in property or a pension?’ Pension flexibilities have also resulted in many people considering withdrawing their pension to fund alternative investments, such as the purchase of buy-to-let (BTL) property. In this article we compare and contrast the advantages and disadvantages of each.
The basics are straightforward:
The pension provider will not contact the pension holder on a Saturday evening to advise that the boiler has broken down.
Whilst most of these may be deductible from any profit made, a pension with such high annual fees (letting agent fees of 10% etc.) would be frowned upon by customer and regulator alike.
There have been a number of recent and ongoing legislative changes in the BTL arena, none of which appear to add any weight to the perceived ‘buy-to-let’ side, including:
Landlords will be able to obtain relief as follows:
With effect from 6 April 2017, there are two new annual tax allowances for individuals of £1,000 each, one for trading and one for property income. The trading allowance will also apply to certain miscellaneous income from providing assets or services.
Where the allowances cover all of an individual’s relevant income (before expenses) then they will no longer have to declare or pay tax on this income.
Those with higher amounts of income will have the choice, when calculating their taxable profits, of deducting the allowance from their receipts, instead of deducting the actual allowable expenses. The trading allowance will also apply for Class 4 National Insurance contribution purposes.
The new allowances will not apply to partnership income from carrying on a trade, profession or property business in partnership.
The allowances will not apply in addition to relief given under the Rent-a-Room Scheme legislation.
The budget on 29 October 2018 introduced a change to Private Residence Relief that commenced from April 2020. The final period of ownership that is exempt from CGT is to reduce from 18 to 9 months. This represents a further reduction as until 2014 this was a period of the final 36 months.
Additionally from April 2020 lettings relief is only available if the owner and the tenant are in shared accommodation.
So is investing in property instead of a pension, or even ‘cashing out’ your pension and buying residential buy-to-let properties a good idea? Let’s have a look at Richard.
Richard has accumulated a pension pot of £300,000.Walking past his local estate agent he takes a shine to a property in the window. He thinks buying this property and renting it out might provide better returns than leaving the money within his pension, so he calls his pension provider and cashes in his whole pension pot to buy the property.
He already has earnings of £30,000 pa; therefore the pension withdrawal will result in a loss of Richard’s Personal Allowance and an additional tax bill of £96,224 (tax bill of £99,710 with pension withdrawal, compared to £3,486 without). In reality, because the withdrawal is likely to be subject to Emergency Month 1 tax (common referred to as emergency tax) the initial tax bill is likely to be £99,525, although he will be able to claim any tax ‘overpayment’ back from HMRC. Please note that the above calculations have being completed using UK tax rates and tax bands, if Richard was a Scottish taxpayer the figures would be slightly different due to the introduction of the Scottish Rate of Income Tax .
If we assume he has additional funds to address the initial cash flow issue caused by emergency tax, there would be £203,776 of his pension fund left to purchase the property.
Out of this amount a number of costs need to be taken into account. These may include (based on a £200,000 property):
So with estimated costs of £10,875, it leaves Richard with £192,901 to buy the property – unfortunately not enough for the £200,000 property he had in mind, so despite starting off with £300,000 in his pension fund he now needs to find £7,099 from other sources to fund the purchase.
Richard has elected to rent out his property via a letting agent, as he doesn’t want the hassle of advertising the property, interviewing/vetting potential tenants, arranging tenancy agreements, collecting rent, completing inspections etc. The agents selected charge 15% of the gross rental income for the services they provide, but they have managed to find a tenant prepared to rent the property for £1,000 per month, the tenant also takes care of the property so he incurs no costs in replacing damaged fixtures and fittings, so Richard is delighted.
Of course Richard also has to pay tax on the rental amount, after the letting agent fee, so his annual income from the property will be:
£1,000 x 12 = £12,000 – 15% = £10,200 – 20% (basic rate tax) = £8,160. (Obviously this may be higher in the initial period as the pension withdrawal has resulted in Richard being an additional rate tax payer in the tax-year that he made the pension withdrawal).
This may sound attractive, however, there are a number of issues Richard needs to consider:
As a net income, relative to his original pension fund (£300,000) and the additional £7,099, the net yield from the rent is actually only 2.66% pa. Perhaps not as attractive as Richard initially thought it would be. He wonders how this compares with the yield his pension would have produced had he left the funds within his pension. If a mortgage was involved, for higher/additional rate taxpayers, the impact of the tax relief on buy-to-let mortgage interest payments could further reduce the yield.
As well as considering if he would have been better leaving his money in the pension Richard will have to consider a number of additional issues as a result of his decision to invest directly in buy-to-let property, including:
Of course, if Richard is adamant that property is his preferred investment of choice, he could have accessed the investment potential of property (albeit commercial) via a Self-Invested Personal Pension and/or investing in the various pension property funds (although we need to be mindful that Pension Property Funds may have the right to defer encashment or switching out of these funds in periods of high volatility, usually for a period of up to 6 months). Looking at each of these:
Within a Self-Invested Personal Pension Plan most providers permit direct purchase of commercial property, such as offices, retail units and factories. Commercial property can produce substantial yields.
While the risks attached to property values/ rental income/ void periods remain; as the investment stays within the pension the preferential tax treatment of pension investments is preserved, such as exemption from income tax, CGT and normally IHT.
The cost of the SIPP will likely be higher than standard Personal Pension plans, and the trustees will make additional charges for facilitating the direct purchase of commercial property, so this needs to be taken into consideration. Other indirect property investments are also available to SIPP investors.
Collective investment in property, via various pension property funds, provides indirect access to many property based opportunities. Most providers have a property fund and may give access to other provider’s property funds.
These funds can usually be accessed within standard Personal Pensions, which usually enjoy a lower charging structure than SIPPs. Richard can then sit back and let the fund manager make all the decisions, and because the funds remain within the pension, the preferential tax treatment is retained.
Additionally, as there will be professional property managers involved Richard will not receive a call from tenants to complain about a broken boiler!
It is important to consider all available options when undertaking financial planning.
Things to think about include:
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