Buy to Let Pension Plan. Paying Tax Twice on Your Pension

Buy to Let Pension – 68% of Pensioners to Cash in 100% of their Pension Pot

Under new pension freedoms as of April 1st, 2015, pensioners are seriously considering cashing in their pension pots to buy property. We have fielded several calls from pensioners who are deciding to go down the same route. Many expats in particular are considering cashing in their entire live savings in order to buy property in the UK or abroad. We explain how taxes, fees and costs can quite quickly destroy your best laid pension plans.

buy-to-let-pension

Buy to Let Pension Plan Warning

“We will show how cashing in your pension to purchase a buy-to-let property will cost nearly 40% of your pension pot to be wiped out”

According to government figures, the number of households renting privately increased from around 2 million in 2000 to 3.6 million in 2010-11. This could explode under the new pension regulations and push up an already extended property bubble making houses out of reach to young people. The effect of all the house improvement shows in the UK along with people cashing in their pensions could lead to 5m or more houses being rented out.

But, is this the best place to put pension monies?

In fact 68% or nearly two thirds of all pensioners are thinking about buying a house, apartment or villa with their hard earned pension from their UK SIPP according to UCB Home Loans, a prominent UK mortgage broker. That is up from 1 in 3 who were going to use property in retirement as income in October last year.

Mortgage brokers will be vying with financial advisers to give advice to pensioners. Mortgage brokers have a strong belief in property with over half of them owning buy-to-let property themselves. But, you would imagine, mortgage brokers have snapped up the best properties already, whilst financial advisers can invest in the same investments they purchase themselves.

This is a dream for some, but it can easily turn into a nightmare and not quite the returns that you would expect and we will explain why.

Reasons to Buy Property with Your UK Pension

  • These are the rationale that anyone would think for buying a second house.
  • You can always live in the second house or give to children
  • You can receive an approximate 5% rental income, plus any capital gains
    For expats, it is difficult to get mortgages
  • We will then pick this apart and show you why it is rarely a great option. Leave property development for the professionals. You should buy property to live in rather than gambling as an investment whilst UK property has already soared past 2007 highs.

The Flawed Buy to Let Plan for UK Pensions

  • You can always rent a house or villa. If you are moving to Spain or Thailand, for example, renting is a very cheap way to stay in a house. If house prices come crashing down you are unaffected and it gives you the freedom to move to any other house you want fairly quickly. Many people were burnt by Spanish and Portugese house prices which are down over 40% from 2008.
  • The 5% income gets eaten into very quickly. Not only are you likely to pay tax on this income, but also tax on capital gains of up to 28%, IHT at 40% and stamp duty at up to 15%. You are effectively paying income tax TWICE!
  • More tax problems. Your pension pot cash-in would face marginal rate tax of up to 45% after you take your cash-free lump sum, eroding your starting capital.
  • This income also gets eaten into with costs. You have to pay maintenance fees, ground-keeping fees, management fees, real estate fees, advertising fees, legal fees and title deed fees to name a few.

House prices in London are near all-time highs, you are likely to have missed a lot of the gains already and could be exposing yourself to a housing bubble. We still think houses will likely rise with the new pension freedoms and tight supply, but at some point reality will come crashing in as wages are stagnant whilst house prices have been continually rising. We feel this is unsustainable in the long run.

  • Lack of liquidity. When house prices fall, you can get caught in a negative equity trap, where your house might be worth less than you bought it for and even eat up your equity.
  • Exchange rate problems. You could be earning in Pounds, but the Pound has been falling against the EUR and other Asia currencies abroad as world demographics and income shifts. This means your pension income stream might be less.

Buy-to-let Property Purchase with UK Pension Example

The Telegraph had a very good illustration to show you what happens with the purchase of a buy-to-let property with your pension under the new pension freedoms and tax law in the UK.

The full encashment of your pension pot is subject to income tax at your marginal rate. This would mean, for example, an expat, with no other UK income and usually no UK income tax to pay, would, from a £300,000 pension plan, get £212,623 after tax. Let’s say you get 5% income after taxes, real estate fees, legal fees, etc. This is being generous. Your income stream would be around 10,000 GBP per year.

This is an overall tax of 39% on your pension pot after cashing in for a buy to let pension plan after taking the maximum 25% tax-free cash of £75,000 or almost 29% of the total. The £300,000 property he was planning to buy will now be a £200,000 property (with a corresponding reduction in rental income).

Buying UK Equities and Bonds with UK Pension Example

Now let’s assume you invest your 300k and it makes 7% per year after fees. After 10 years, your pension is now worth 590,000 GBP. Now, you can take 30% tax free as an expat if you purchase a QROPS which means you have 177k to buy a house or spend in cash and you still have 414,000 GBP pension pot which can pay you an annual income of about 21,000 GBP per year. You have doubled your income and still bought a house by waiting 10 years.

This would also avoid any UK income tax and tax on death as an expat. You can pass on the entire 590,000 GBP pension pot to your loved ones tax-free whilst in the first case, your pension would face a 45% tax on death if taken as a lump sum after 75.

The point is you can choose. You can take a higher lump sum and put 300k into a house at this stage or perhaps just take 70k GBP as a downpayment and use the rest to pay you a pension. This way, you have used the power of investment and compound interest to give you a high income in retirement.

Conclusion to Buy-to-let Investments from a UK Pension

Whilst there are no perfect answers, we feel that many publications, the media, mortgage brokers and the government are pushing people to spend their lifelong savings, to increase the housing bubble in the UK and thus make it even harder for young people to buy houses and get into the market. Sensible pension planners can take advantage of the power of compound interest and wise investment to target higher returns by investing their pensions and delaying retirement income.

A Credit Card Linked to Your Pension – Great News!

Credit Card Linked Pensions are Coming

Credit cards for pensioners are coming… Well whoopee doo, another feather in the cap for George Osbourne and the death knell for pensions in the UK. This is just what the man on the street needs like a bullet in the head… more debt!

credit-card-linked-pension

How about more education on the role of compound interest in a pension pot or how to save earlier or how to invest wisely?

The ‘I want it now generation’ are going to get what they want and this short term political planning will do a massive disservice both to the next generation and to baby boomers who will look to their pensions for easy money rather than looking outside their pension pots, for example downgrading their main residence or selling some of their other assets.

“Wake Up Savers” – your pension is not a bank account despite reports in the Telegraph that a pensions company, Pennywise will be offering credit cards linked to pensions.

Your pension should be their to give you an income for life.

Something that the government have now backtracked on. HMRC clamped down tightly on schemes before such as QROPS in New Zealand which allowed pensioners 100% cash in, but now they have done an ubrupt U-turn.

George Osbourne changed the tax rules last year which opened up UK pensions and gave investment decisions back to pensioners. They can now choose when to take their pension and aren’t locked in under old GAD rules. They can take as much as they like.

On the face of it, this is a good thing right. You worked hard for your money and you should be able to take as much of your pension whenever you want, right? Wrong. Less than 20% of fund managers who manage money on a daily basis can beat the market, what is the chance of Joe Bloggs getting it right with little to no financial education. Even the experts can’t agree and have trouble getting it right, but at least most of the experts understand risk.

How this credit card work is a mystery as such and even though there are pension freedoms, it would be difficult to make this work given the restrictions at the moment or could end in default and heavy charges for consumers.

The strategy director at Legal & General says it best, “A pension scheme is not like a bank account. If you want to take money out, even under the new flexibilities, you have a raft of HMRC paperwork to go through, and it will take at least a couple of weeks to get the money out.

“I think consumers have been given completely false expectations by the media, and that will eventually come home to roost.”

Adrian Boulding continues, “The other thing I would say to consumers is that they can only spend the money once. I have a bank account that is topped up every month because I earn some more money in the form of my salary. This pension account can only be spent once by consumers.”

Legal & General are a large established conservative insurance company. But, as new entrants like Wonga have proved, first mover advantage will favour anyone who opens a credit card linked pension account.

But, anyone setting up such a service would be doing pensioners a massive disfavor. Why?

1. Understanding the taxation. The lump sum would be taxed 25% and the rest would be at the marginal rate of tax of 20% to 45%. The company may have to employ a withholding tax with clients perhaps overpaying and spending months to get tax back from HMRC, if they can work it out and be bothered to file the tax report.
2. Loss of compound interest and fund growth. Your pension grows each year with compound interest. That is what can turn a 200k pension into 400k in 7 years. If you chip away at 55, you might have spent your pension by 65, whilst a prudent investor who waits until he is 65, can live off a pension of at least 20k per year.
3. Living longer. We are all living longer. Men who reach 65 can expect to live until 84. It is 86 for women. What is the pensioner going to do who has spent their pension by 65?
4. We are living longer, but not healthier. Spending your pension earlier could well mean working later in life, but is this realistic? 59% of people aged 65-74 and 66% of people aged 75 and over have a long term illness. 24% of those aged 75 and over had attended the casualty or out-patients department of a hospital (General Household Survey stats).

If you want to look after yourself later in life, rip up your current credit cards or link them to your debit card and pay off any loans you have. For younger people, start saving earlier, it is not timing the market that matters, but time in the market. Compound interest works wonders.

For those lucky enough to be British expats, you can avoid all taxes on death on your pension and most of the tax on income through a transfer to an offshore pension via a QROPS.