The subject of a buy-to-let pension fund came up in our Best Practice meeting earlier this week.
We have these meetings on a regular basis and debate economic, market and regulatory changes and the impact these will have on our clients.
One of the changes announced in the Budget is the ability from next April for a pension plan holder to take the whole of their pension fund as a lump sum.
This week we were discussing whether people will actually do that and use their fund (net of income tax at their marginal income tax rate) to purchase residential property.
That property might then be tenanted and the rental income being used as an alternative to annuity income or income drawdown.
Will people actually do this? If they do, will they understand that they are replacing one set of risks (associated with the annuity or income drawdown) with another set of risks associated with investing in one asset class and one specific asset within that class?
Like with every financial decision that we make during our lives, there will be advantages and disadvantages.
I think it is well worth noting the disadvantages otherwise pension plan holders might just get caught up in the excitement of becoming a landlord.
-25% of the pension plan is available as a tax free cash lump sum. 75% of the pension plan value will be taxed as income and will result in a marginal rate of tax based on 20%, 40% and 45% income tax rates. The monetary amount of income tax due will depend upon the earnings of the individual and the value of her pension fund;
-There are costs associated with buying property. The costs of conveyance need to be taken into consideration. If an agent is used to “manage” the property they will also have charges that need to be taken into account;
-There may be periods of time when the property is without a rent paying tenant. This means that the owner will receive no income. If the property has been purchased with the aid of a mortgage then the buyer needs to note that he will still have to pay the interest due on the loan so it makes real sense to carry out some “stress testing” to ensure that the asset is not lost simply because the borrower could not keep up the mortgage repayments;
-When the property is ultimately sold it may well be subject to Capital Gains Tax;
-In the event of the death of the property owner the value of the property will form part of their estate for inheritance tax purposes;
-Buy to let property can fall in value as well as rise so it is not a given that there will be a capital profit in the future to enjoy;
-Buy to let property might also turn out to be an illiquid asset and it may not be easy in the future to convert bricks and mortar back into cash.
Using the pension fund to purchase buy to let property might be the right thing for some people to do, but it is not for everyone.
Also some of the above risks, taxation and costs apply equally to buying an annuity or income drawdown, I am not saying one is right and one is wrong.
Each pension plan holder needs to consider all of their choices and options before committing their pension fund, at retirement, to a particular route.
