31st October 2017 at 1:39pm
When it comes to planning for your future, pensions can certainly play a big part. But what about property, or buy-to-let in particular?
It’s been an attractive option for many people over the years as a way to help fund their retirement. But recent tax changes have affected the buy-to-let market.
What could these mean if property – the solid attraction of bricks and mortar – still appeals to you? And can one support the other?
Property, what’s changed on the tax front?
Here’s what you need to know.
- Stamp duty has increased: If you’re buying, an extra 3% in stamp duty is now payable on all second property purchases.
Buying a £200,000 property now costs £7,500 in stamp duty. Before the change in April 2016, it would have been just £1,500.
- The cost of borrowing has gone up: Until this tax year, higher-rate taxpaying landlords could deduct their buy-to-let mortgage interest from their taxable income. So the net cost on annual interest of £10,000 would be £6,000. But tax relief is being gradually reduced from April 2017, and will be limited to just the basic rate by 6th April 2020 . This will see the same mortgage interest eventually costing £8,000 a year – a £2,000 difference.
- Capital Gains Tax (CGT) needs paid more quickly: From April 2019, CGT on the sale of second homes will need to be paid within 30 days of the sale. At the moment, any CGT due has to be paid by 31 January in the tax year after you sell, which could be as long as 21 months. Plus, CGT rates on property are higher at 18% and 28% than the 10% and 20% payable on shares for example.
Taking into account these changes, it might seem that many of the likely benefits of property as a way to fund retirement are being stripped away.
Rather than having all their eggs in the property basket, landlords could see some real benefits of having a pension alongside to help with cash when it’s needed. It’s worth remembering that pensions are long-term investments and there’s always the chance you could get back less than you paid in.
‘My properties are my pension’
For many landlords, their rental income is their retirement income, choosing bricks and mortar over pensions to provide for them in their life after work. This has largely been driven by the potential for rising property prices and often generous rental yields.
Others may just prefer to own a tangible asset, or believe that money tied up in a pension is not easy to access or pass on to their loved ones. Pension freedoms have addressed these concerns.
The best of both worlds
The new pension freedoms can be a really attractive benefit for those with rental properties when they’re over the age of 55.
Over 55s can choose to take as much or as little income from their pension as they want. And for a landlord faced with an unexpected bill to replace a central heating system, or simply looking to help finance renovations on the latest addition to their portfolio, the ability to withdraw capital could prove very useful.
And much easier than trying to release capital from a property. But bear in mind that when you’ve taken your tax-free cash, how much you can pay in and get tax relief on is limited.
Having pension income can also help smooth any shortfalls where there are gaps in tenancy.
The benefit of pension tax relief
Tax relief available on any pension contributions could go some way to offsetting the loss of mortgage interest relief at the higher rates. But landlords will need to have another form of earnings to support large pension contributions, so it may be something to consider before finishing work.
When making large pension contributions it’s important to take into account any potential tax and lifetime allowance implications first. If in doubt we’d always suggest seeking specialist advice. Charges will likely apply for financial advice.
Leaving a legacy
One thing worth considering is how pension and property are treated differently when you’re leaving a legacy.
Unlike rental properties, pensions are generally free of Inheritance Tax (IHT) and can be passed down to family members easily and tax efficiently.
A property could mean IHT has to be paid.
Buy-to-let properties will be included in your estate for IHT. This could mean that family members only inherit 60% of the property’s value. And you can’t use any of the new IHT residence nil rate band that is not used against your main residence.
There can also be delays in obtaining probate and distribution to the beneficiaries if a large part of the estate is tied up in something that needs to be marketed and sold.
Any remaining pension funds can be inherited by your beneficiaries without forming part of the estate. Do bear in mind that you need to name beneficiaries as your Will doesn’t normally cover a pension. Read more about passing your pension on to your loved ones.
What does the future hold?
Tax changes aside, many people are still attracted by the prospect of a buy-to-let and that’s unlikely to change in a country that seems to love property. And people can make a reasonable income if they factor in all the costs.
But when it comes to property ownership and pensions, it doesn’t have to be a case of one or the other.
The information in this blog or any response to comments should not be regarded as financial advice.
A personal pension is an investment and its value can go up or down and may be worth less than you paid in.
Laws and tax rules may change in the future.
The information here is based on our understanding in October 2017. Your personal circumstances also have an impact on tax treatment.