Don’t raid your pension to fund a buy to let

29 October 2015

It stands to reason then that a third of over-50s have already invested in rental property and another 40% say they would do the same if they had the money, according to a poll run by buy-to-let training company Progressive Property.

However, just because you can spend your retirement savings on a rental property, that doesn’t mean you should. In fact, the figures – outlined below – suggest that doing so would be positively reckless.

Your tax bill

“If you have a large pension fund... and withdraw this in one go, then you are likely to be hit with a hefty tax bill because after the first 25% tax-free lump sum, the remainder of the pension withdrawal will be taxed at your marginal rate of income tax,” explains Patrick Connolly, a chartered financial planner at Chase de Vere.

This would reduce a £150,000 pension fund to just £105,000, assuming the rest of the withdrawal after the tax-free 25% lump sum (or £112,500) was taxed at the higher rate of 40%. The individual would also lose their annual income tax personal allowance of £10,600.

But most pensions are not that large. Take the example of a £35,000 pot (the average size according to Retirement Advantage). It would provide a tax-free lump sum of £8,750 and basic-rate payers would see tax erode the £26,250 remainder to £21,000. So raiding a £35,000 pension to fund a property purchase would deplete your fund by 15%. You would then be relying on rising house prices and a healthy yield to replace the money you’d have lost before you could even think about turning a profit.

Danny Cox, head of financial planning at Hargreaves Lansdown, agrees. His own maths reveals that for someone with no other income and taking £100,000 out of their pension, then even with 25% tax-free cash they’d still be subject to £19,403 in tax. “If they already have an income of £15,000 a year, the tax rises to £24,523, reducing the net sum received to £75,477,” he adds.

If that £75,477 is invested in property, its value needs to grow by a third just to get back to where you started out – and that’s before paying stamp duty. Which, on a £200,000 property, costs £1,500.

Cox adds: “In the interim, the rental yield of, say, 4% produces £3,000 gross a year. If they take the tax-free lump sum and invest that for income in an Isa over two tax years paying, say, 4%, then they’d make a £1,000. Draw 4% a year from the remaining pot of £75,000 and that’s the equivalent of £3,000 gross. So the income is £1,000 a year better.”

By taking cash out of your pension, Connolly adds that you’ll also be losing valuable tax benefits. “You will be moving your money outside of a tax-efficient wrapper where it will currently benefit from tax-efficient growth, no capital gains tax liability and where the money will be outside of your estate for inheritance tax purposes.”

Don’t put all your eggs in one basket

Connolly also warns that investing in a single property is a risky strategy, because you lose out on having an entire range of investments and asset classes, which helps to spread risk.

You should also bear in mind that property prices can fall, especially when interest rates eventually go up and mortgage payments become more costly.

Then there’s also the risk of not being able to find tenants for prolonged periods or that tenants might create unnecessary hassle and costs.

Be realistic

Cox warns pensioners to think very carefully before buying a rental property. “Most people go into buy to let thinking it will grow hugely and give them a capital return and rental income will cover any mortgage payments. The reality is that retired people need income and realising the capital return from property means selling and all the capital gains and costs associated with that.”

When buy to let can work

However, that’s not to say you shouldn’t invest. If you have non pension savings and can afford to buy a property outright, or even with a mortgage, buy to let can prove a very worthwhile investment – but you should follow a few golden rules:

Rental property should never be an emotional purchase. How you feel about its looks or charm is irrelevant – what matters is the location and practicality. “Ask at least three local letting agents for the areas where they’re seeing strong tenant demand and find out what renters want from property – one bedroom or two?” suggests Mark Homer, who has bought and sold more than 400 properties over the past decade and co-founded Progressive Property.

Most buy-to-let mortgage lenders require a minimum deposit of 25% but Homer says that doesn’t necessarily mean you’ll have to find huge amounts of cash. “In a lot of UK cities, a £50,000 deposit is enough to get you a 50% loan-to-value (LTV) mortgage on a rental property,” he explains. A benefit of this is that you’ll be far less susceptible to falling house prices.”

Some specialist lenders will also go beyond retirement age. For example, The Mortgage Works takes applications from borrowers up to the age of 70 and offers them mortgage terms of up to 35 years. Aldermore and Kent Reliance take applications from anyone up to the age of 85, and Lloyds’ commercial mortgages are available to adults of any age - but do require evidence of a succession plan in place for older clients.

Succession planning however can be helpful for all older investors. Involving your children at outset will not only make life easier when you do die, they may also have more energy to help with maintenance and tenant issues as you get older.