Don’t raid your pension to fund a buy to let
It stands to reason then that a third of over-50s have already invested in rental property and another 40% say they would do the same if they had the money, according to a poll run by buy-to-let training company Progressive Property.
However, just because you can spend your retirement savings on a rental property, that doesn’t mean you should. In fact, the figures – outlined below – suggest that doing so would be positively reckless.
Your tax bill
“If you have a large pension fund... and withdraw this in one go, then you are likely to be hit with a hefty tax bill because after the first 25% tax-free lump sum, the remainder of the pension withdrawal will be taxed at your marginal rate of income tax,” explains Patrick Connolly, a chartered financial planner at Chase de Vere.
This would reduce a £150,000 pension fund to just £105,000, assuming the rest of the withdrawal after the tax-free 25% lump sum (or £112,500) was taxed at the higher rate of 40%. The individual would also lose their annual income tax personal allowance of £10,600.
But most pensions are not that large. Take the example of a £35,000 pot (the average size according to Retirement Advantage). It would provide a tax-free lump sum of £8,750 and basic-rate payers would see tax erode the £26,250 remainder to £21,000. So raiding a £35,000 pension to fund a property purchase would deplete your fund by 15%. You would then be relying on rising house prices and a healthy yield to replace the money you’d have lost before you could even think about turning a profit.
Danny Cox, head of financial planning at Hargreaves Lansdown, agrees. His own maths reveals that for someone with no other income and taking £100,000 out of their pension, then even with 25% tax-free cash they’d still be subject to £19,403 in tax. “If they already have an income of £15,000 a year, the tax rises to £24,523, reducing the net sum received to £75,477,” he adds.
If that £75,477 is invested in property, its value needs to grow by a third just to get back to where you started out – and that’s before paying stamp duty. Which, on a £200,000 property, costs £1,500.
Cox adds: “In the interim, the rental yield of, say, 4% produces £3,000 gross a year. If they take the tax-free lump sum and invest that for income in an Isa over two tax years paying, say, 4%, then they’d make a £1,000. Draw 4% a year from the remaining pot of £75,000 and that’s the equivalent of £3,000 gross. So the income is £1,000 a year better.”
By taking cash out of your pension, Connolly adds that you’ll also be losing valuable tax benefits. “You will be moving your money outside of a tax-efficient wrapper where it will currently benefit from tax-efficient growth, no capital gains tax liability and where the money will be outside of your estate for inheritance tax purposes.”
Don’t put all your eggs in one basket
Connolly also warns that investing in a single property is a risky strategy, because you lose out on having an entire range of investments and asset classes, which helps to spread risk.
You should also bear in mind that property prices can fall, especially when interest rates eventually go up and mortgage payments become more costly.
Then there’s also the risk of not being able to find tenants for prolonged periods or that tenants might create unnecessary hassle and costs.
Cox warns pensioners to think very carefully before buying a rental property. “Most people go into buy to let thinking it will grow hugely and give them a capital return and rental income will cover any mortgage payments. The reality is that retired people need income and realising the capital return from property means selling and all the capital gains and costs associated with that.”
When buy to let can work
However, that’s not to say you shouldn’t invest. If you have non pension savings and can afford to buy a property outright, or even with a mortgage, buy to let can prove a very worthwhile investment – but you should follow a few golden rules:
Rental property should never be an emotional purchase. How you feel about its looks or charm is irrelevant – what matters is the location and practicality. “Ask at least three local letting agents for the areas where they’re seeing strong tenant demand and find out what renters want from property – one bedroom or two?” suggests Mark Homer, who has bought and sold more than 400 properties over the past decade and co-founded Progressive Property.
Most buy-to-let mortgage lenders require a minimum deposit of 25% but Homer says that doesn’t necessarily mean you’ll have to find huge amounts of cash. “In a lot of UK cities, a £50,000 deposit is enough to get you a 50% loan-to-value (LTV) mortgage on a rental property,” he explains. A benefit of this is that you’ll be far less susceptible to falling house prices.”
Some specialist lenders will also go beyond retirement age. For example, The Mortgage Works takes applications from borrowers up to the age of 70 and offers them mortgage terms of up to 35 years. Aldermore and Kent Reliance take applications from anyone up to the age of 85, and Lloyds’ commercial mortgages are available to adults of any age - but do require evidence of a succession plan in place for older clients.
Succession planning however can be helpful for all older investors. Involving your children at outset will not only make life easier when you do die, they may also have more energy to help with maintenance and tenant issues as you get older.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.