In 2015 the government introduced new ‘pension flexibility’ rules which allow those over 55, who have a defined contributions pension scheme, to take money directly from their pension pot without having to buy an annuity or put the money into drawdown.
Tempted by rising property prices and high rents some near-retirees are considering using their personal pension pot to invest in buy-to-let property.
But it pays to do the sums first to check whether the investment is going to deliver the expected income.
Here we investigate the ins and outs of whether it is wise to use a pension fund to purchase a buy-to-let property.
Can I use my pension to buy a house?
You can choose to cash in some of your pension pot and use it to buy residential property – either to live in yourself, as a second home or to rent out. You can withdraw 25% of your pension pot tax free, but anything above that is taxed according to your tax bracket – this can be as much as 45%.
Inheritance tax considerations
Money left in your personal pension when you die is not subject to inheritance tax. This is because, unlike other investments, your pension isn’t part of your taxable estate.
If you bought a house with your invested pension savings, the property will form part of your estate and will be subject to inheritance tax.
Money invested in a pension is spread over different asset classes which reduces your risk of losses. Not all your stocks and funds will increase in value, but at least some of them will. If you invest solely (or mainly) in property, your wealth is heavily dependent on the property market.
Also, housing is a comparatively illiquid asset so you will not be able to access the cash quickly if required.
How long will it take to make your money back?
If you withdrew your entire pot of £500,000 from your pension to buy a residential property a 40% tax payer would pay £150,000 in tax.
You will also need to pay stamp duty, a 3% surcharge is applied to any property which is not the owner’s main residence. For sales completed before 31st March 2021 you would pay £15,000 in stamp duty on a £500,000 property. From 1st April 2021, when the stamp duty holiday ends, the bill will be £30,000.
There are also costs associated with buying the property itself including solicitors and surveyors’ fees as well any mortgage fees, if you are using a mortgage to fund part of the purchase.
Based on house price growth of 1.25% and a rental yield of 6% it would take around 5 years to earn this money back.
This doesn’t include the various costs involved in being a landlord.
How much can you make in rental yields?
When contemplating a property investment, you need to calculate the rental yield – the rental return as a percentage figure of the property purchase price. Prospective landlords can compare this to the amount of income they would expect to receive from other pension investments.
Check out our blog article ‘How to Work Out and Calculate Rental Yield for UK Properties’.
Rental yields tend to compare favourably with the interest you would receive putting the money in a saving account, but investment funds often give comparable returns – and your investment fund is not going to phone you up complaining about a broken washing machine.
The costs of being a landlord
If you are planning to let the property out, you should factor in the costs of letting agents, property managers, repairs and maintenance costs as well as the risk that the property will be empty for periods of time or your tenants may not pay their rent.
You will also need to pay tax on the profit you make. Landlords can no longer offset mortgage interest payments against their profits so tax bills from buy-to-let properties are much higher than they once were.
Weighing up the options
Investing in buy-to-let property to provide retirement income can be an effective strategy. Residential letting offers an income that rises with inflation, and you stand to make considerable gains from rising property prices.
However, the tax bill when you take your money out of your pension could decimate your profits. You may find that you receive a better return from leaving your money in your pension.
Before making financial decisions, make sure you do your research and sums as well as seek advice from a financial advisor.
If you are thinking of investing in a buy-to-let property in Wimbledon or the surrounding area we can advise you on the type of properties that rent well and yield you can expect. Get in touch with our property experts today.