Is a buy-to-let property pension worth it?
Steve Sims looks at whether it's a good investment to take funds from a pension and invest it into a buy to let.
Thousands of would-be landlords can take cash from their pensions to purchase buy to let homes when pension rules change in April, but is moving money into property a good investment? People have long had a love affair with owning property, fuelled by aspirational television programmes and regular articles in the press about rising house prices.
From April 2015, retirement savers over 55 years old can take money from their pensions to spend how they like – and many estate agents and property experts are predicting buy to let property is high on their shopping lists.
However, before ploughing their retirement money into a property purchase, many pension savers need to ask some tough financial questions.
Will I earn more from a buy to let than other investments?
Yield is a measure of the annual return retirement savers are paid on their investment cash. Putting money into a pension gives a typical yield of 5% - the average annual target for most pension fund managers. The yield from a buy to let can vary – latest figures from leading letting agents show the average buy to let property yield is also 5% and dropping slightly as house prices rise.
The relationship between property values and rents means that as house prices rise, yield drops but this is balanced by a rise in the value of the home.
What about money banked from rising property values?
The superheated housing market of a few years ago has long passed. Property prices have risen in recent years, but are slowing. Besides that, buy to let is a long-term strategy and although property may rise in value, landlords do not benefit from any gain in value until a property is sold – and then capital gains tax is due on any profits.
Cash invested in pensions grows free of capital gains tax.
The pension drawdown tax trap
The new drawdown rules let a retirement saver take as much money as they wish from their pension – but the catch is although the first 25% of any withdrawal is tax-free, income tax is due on the balance.
Which? Money magazine has worked out the average buy to let property prices and yields for different regions of the UK and then related this back to how big a pension pot is needed to fund the purchase of one of these homes. The magazine says the cheapest average home price in the UK is £99,132 is in the North East, which returns a 5% yield. To buy outright, a pension withdrawal of £130,621 is needed to buy one of these homes to include the tax bill of £28,589.
The best yield is 7.1% in the North West. There, the average home price is £110,548. Investors would need a pension drawdown of £150,638 on which they would pay tax of £37,190 to buy a buy to let home in the North West.
Less money is needed if the buy to let home is bought with a mortgage, but the problem is some of the rental income goes to pay off the loan rather than providing an income from cash invested from a pension. This rather defeats the idea of saving in a pension to give an income in old age.
Property investors also have to consider that cash lost to tax if they drawdown on a pension to buy homes to rent out. For instance, replacing that £28,589 tax bill on drawing down the money to buy a buy to let in the North East is likely to eat up any letting profits for many years.
A 5% yield on a home costing £99,132 provides an annual cash equivalent return of £4,956 before any bills are paid, such as insurance, repairs and letting agent fees.
Tax paid on a pension lump sum
The figures assume no other income is received during the year
|Pension Drawdown||25% Tax-Free||Taxable balance||Tax due||Net drawdown|
Lack of diversity
An important aspect of investing is not putting all your eggs in one basket.
Concentrating your investment goals on property is risky. Property prices can go up and down and homes can take a while to sell if you need to raise cash.
Other forces also come into play, like having to maintain a property and find tenants.
Most portfolios spread the risk across different investments, so if one performs badly another hopefully steps up to generate profits to cover the loss.
Taking all of the cash out of a pension to invest into buy to let is an expensive and dangerous strategy.
Crunching the numbers
The vital question to answer is will a property investor earn more money from buy to let than any other investment?
Crunching the numbers to look at yield will give a good indication of the answer.
Don’t forget to factor in property voids – times when a buy to let has no income from a tenant and the landlord has to finance the bills.
Also think about who will manage the property and the costs involved in running a buy to let. A letting agent will typically charge between 8% and 15% plus VAT of the monthly rent for a full management contract.
You will need a contingency fund for repairs and maintenance, and other costs like mortgage interest, insurance, licensing and safety certificates.
If the figure left after deducting all these expenses from the rent is less than the average return on the investment from your pension, then that probably signals the end of any buy to let dream.