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10 Nov 2019

Should you invest your pension pot in a buy-to-let property?

Retirement savers consider emptying pension pots for property investment

Middle-aged savers are toying with the idea of withdrawing from their pension savings to invest in buy-to-let property, according to new research.

This comes as official data shows that savers have cashed in £2.4bn from their pots in the past year, sparking concern from industry experts.

Here, we explore the pros and cons of using your retirement savings to invest in property, and highlight the alternatives worth considering.

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Retirement savers tempted by buy-to-let

In a poll by YouGov for insurer Royal London, three in 10 people aged between 45 and 54 said they were considering accessing their retirement funds to purchase a buy-to-let property.

Royal London says that such a move can be an expensive mistake. It claims that, on a £400,000 pension, savers would need to pay £120,000 in income tax if they withdraw the full amount in one lump sum.

The insurer says that this, combined with the additional costs of buying an extra property (such as the 3% stamp duty surcharge), adds up to an expensive and risky investment.

Fiona Hanrahan of Royal London said: 'There is little understanding of how pension lump sums are taxed, and people could find out too late and lose many thousands of pounds.

'We would urge anyone thinking of going down this route to speak to a financial adviser to go through their options.'

Why are more people accessing their pension funds?

Since the pension freedoms were introduced in 2015, people have been able to access cash from defined contribution (DC) pensions from the age of 55 without needing to buy an annuity. The first 25% of the pot can be taken tax-free.

Data from HMRC shows that savers withdrew £2.4bn from their pots between July and September this year, an increase of 21% year-on-year.

Perhaps most worryingly, the Financial Conduct Authority (FCA) says that 48% of pots are accessed without the holder taking regulated financial advice.

This opens up the possibility of people making risky and uninformed decisions over how to spend their retirement savings.

Is investing in property a good idea?

Property has historically represented a good investment for many people, with house prices increasing fourfold between 1987 and 2017. And with savings accounts currently offering little by way of returns, some people are instead pumping their money into bricks and mortar.

The problem is that the market has slowed down over the past couple of years. Data from the Land Registry shows that prices increased by just 1.3% in the year to August 2019, compared with 2.7% the previous year, and homes in some areas are now losing value.

While this means you might be able to bag a buy-to-let bargain, stagnating prices place a great deal of stress on how much profit you can make on rental income (known as the rental yield).

How long will it take to make your money back?

A saver withdrawing their full £400,000 pension pot to invest in property in England might pay out a total of £132,400 in tax and stamp duty.

The estate agency Hamptons International estimates it would then take them six and a half years to earn their money back on a buy-to-let.

This estimate is based on house price growth of 1.24% a year and a rather generous rental yield of 6%. It doesn't take into account the various costs of being a landlord, such as repairs, maintenance and void periods.

How much can you make in rental yields?

You'll need to do a significant amount of research to ensure you buy the right type of property in the right area - and even then there's no guarantee of getting a big yield.

The credit broker Totally Money looked at data from nearly 500,000 properties across England, Scotland and Wales, and estimated that actual rental yields run from just 1.95% (the AL5 postcode in St Albans) to 10% (the L1 postcode in Liverpool).

Many of the best yields were recorded in cheaper areas in the North of England and Scotland, while the lowest yields were generally recorded in London and the South East of England.

It's not all bad news for investors, however. The latest rental price tracker from Rightmove shows that a shortage in the number of rental homes on the market means that annual rents are rising by around 5.6% in London and a little over 3% in the rest of the country.

The costs of being a landlord

Even if you can find a suitable property, it's currently a very complicated time to become a landlord.

As well as dealing with bread-and-butter issues such as finding tenants, you'll need to battle with ever-changing regulations and increasing amounts of red tape.

  • Stamp duty: the 3% stamp duty surcharge for buy-to-let investors was introduced in 2016 and has seen many landlords sell up and leave the market.
  • Mortgage interest tax relief: landlords could once offset their mortgage interest against their profits when filing a tax return, but this is being phased out. From the 2020-21 tax year, it will be replaced by a flat-rate 20% credit, leaving many landlords out of pocket.
  • Selective licensing rules: local authorities are now able to impose their own licensing systems for landlords, and these vary significantly between councils. A mixture of red tape, delays in processing, high admin fees and the prospect of large fines is an additional headache for landlords.

Alternatives to investing in property

If you're thinking of cashing in some of your pension, you don't have to access all of your funds at once.

The FCA says that more than 350,000 pots were fully withdrawn in 2018-19, but that 90% of these had less than £30,000 in savings.

This shows a trend for people with smaller additional pension savings accessing cash, while keeping their main pots for retirement.

Gambling on your retirement income is a significant risk, so you should always take independent financial advice before withdrawing from your pension.

A couple of popular alternatives to full withdrawals are:

Income drawdown

Instead of withdrawing all of your cash in one go (and facing the tax burden of doing so) you can take regular monthly or annual payments using an income drawdown plan.

Income drawdown will mean your savings will continue to be invested and will allow you the freedom to take out different amounts each year and manage your annual tax liability.

The FCA says 190,971 people used income drawdown in 2018-19.

Buying an annuity

Buying an annuity allows you to swap some of your pension savings for a guaranteed income for the rest of your life.

How much you'll get depends on various factors, including your health, the size of your pot and the rates currently offered by providers.

The FCA says that 73,977 pension plans were accessed to buy an annuity in 2018-19.