DECEMBER 2015 - Pensions v Buy-to-Let
Pensions V Buy to Let
Over the last twenty years or so, the way people save for their retirement changed, with many deciding to shun paying into a pension, and instead purchase a second property to rent out.
With property values growing at record levels, the cost of borrowing at an all-time low, and no shortage of people looking to rent, the boom in Buy to Let seemed set to continue unabated. Add to this the fact that the rental income you received had the ability to increase in line with the cost of living, and you could leave a Buy to Let property to your family when you died, Buy to Let looked like an attractive choice.
Pensions on the other hand seemed far less attractive. Although you had a much wider range of investments to choose from, unless you had a large fund you had to buy an annuity to provide your retirement income, which was often poor value; additionally when you died, the insurance company got to keep your money! If you did have a large fund the option of Income Drawdown meant that while you were able to retain access to your funds, your family were stung with a tax charge of 55% if you left the fund to anyone other than your spouse.
This led to some people suggesting that pensions were a waste of time and that you would be much better off investing in a Buy to Let property in order to provide for your retirement. However over the last twelve to eighteen months the Government have introduced a number of changes that have started to tip the balance in favour of pensions.
The ‘Pension Freedoms’ introduced in April 2015 now mean that anyone who has reached the age 55 can access the money held in their pension without having to buy an annuity. Instead, you can now take the money out in one go, or as a regular income, or dip into your fund as and when you need it. Up to 25% of the value of the fund can be taken tax-free, while the remainder has to be taxed as earned income.
This also means that any money still left in your pension can be passed on to your family when you die either as a lump sum, or left in tax efficient environment of a pension and drawn out as and when they require it. If you die before the age of 75, the money is tax-free in the hands of whoever you leave it to, while if you die after 75, the money is taxable at the marginal Income Tax rate of whoever inherited the funds.
Despite these changes, pensions remain free from Inheritance Tax meaning the money held in them can be passed down without it being taxed at 40%. Add in the availability of tax relief on your contributions, and the fact that any growth within the fund is free from Capital Gains Tax, and paying in to a pension now looks to be an extremely attractive option.
While the outlook for pensions has improved, for those investing in Buy to Let property, recent changes have been less favourable.
Currently, if you pay interest on a Buy to Let mortgage, you can deduct the interest you pay before calculating any profit you make from the rent. This means that Basic Rate tax payers receive a discount of 20% on their interest costs, Higher Rate taxpayers receive a 40% discount, while Additional Rate taxpayers receive a 45% discount. However the Chancellor announced that over the next four years, this relief will be restricted to the Basic Rate of tax. Depending on the level of rent you receive, this could mean a Buy to Let property purchased with a mortgage ends up costing you money to run. These changes have led to some claims that Buy to Let is no longer a viable investment, particularly for Higher Rate Tax payers who, according to the Daily Telegraph, could see the tax due on their rental income go up by as much as 93% (1)
Another unattractive change to Buy to Let is the removal of the current ‘Wear and Tear’ allowance. This currently enables landlords of furnished properties to claim a discount of 10% on their rental income regardless of whether or not they actually spend any money on repairs. The allowance is being abolished and replaced with a new system that will only allow them to claim for costs that have actually been incurred.
Finally, anyone purchasing a new Buy to Let property from April 2016 will have to pay an additional 3% on the Stamp Duty meaning that an extra 3% of the purchase price will need to be found to actually purchase a property for rent. This translates to an extra £5,000 on a property costing £150,000 and will also apply in Scotland with a similar increase to the Land and Building Transaction Tax.
Other drawbacks to Buy to Let investing include Capital Gains Tax when you sell at either 18% or 28%, the time it takes to find a buyer and the lack of flexibility if you need access to just some money (it is difficult to sell part of a house). It also means that your money is tied up in one section of the market leaving you vulnerable if there is a downturn in property prices or if you struggle to find a tenant. Finally when you die a Buy to Let property forms part of your Estate so could be liable for Inheritance Tax at 40%.
So which is better: pension or Buy to Let property? Well following the changes, the balance appears to have tipped back towards a pension. A pension offers tax relief on contributions, a wider choice of where your money can be invested, and now offers greater flexibility in how you take you money out as well as freedom from Inheritance Tax. Buy to Let can still form a valuable part of your retirement plans however purchasing a second property at the expense of a pension would leave you with less flexibility in the future and a potentially higher tax bill.
1 Source Daily Telegraph 22nd September 2015.
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