Synopsis: Weekend newspapers carry headlines of mass pension fund withdrawal to fund buy to let pension alternative
Date posted: Monday, March 24, 2014
The proposed April 2015 relaxation permitting unrestricted pension fund drawdown to all regardless of ‘pot size’ has carried some predictions of a flood of requests from ‘pension disaffected retirees’ to draw entire funds to invest into property with a view to generating rental income as a ‘pension’.
Apart from the potential extreme lack of diversification (in some cases) such a strategy could represent there is also the obvious (but perhaps overlooked) point that aside from the 25% Pension Commencement Lump Sum (PCLS – i.e. tax free cash) the remainder of the fund withdrawn would suffer income tax at the ‘withdrawer’s’ marginal rate in the tax year of withdrawal.
Say the investor had a fund worth £200,000. £50,000 could be taken as tax free cash.
Say they had £10,000 of their basic rate threshold left in the year of encashment.
The £150,000 would generate tax of £2,000 on £10,000 and £56,000 on £140,000, leaving a net sum to invest of £50,000 (PCLS) + £92,000 = £142,000.
Then there’s stamp duty on the value of property at 1% on a purchase of up to £250,000 which could result in up to another £2,500 gone, aside from any other expenses.
And then, if a property can be purchased (with the tax reduced sum) with a net rental yield of say (a high) 5% the effective yield on the original £200,000 that could have otherwise been used to buy an annuity or remain invested to drawdown from would be 3.5% pa. With a lower net rental yield (a function of property acquisition price and nominal rents available for the property being let) the net (pre tax) yield could easily be lower than 3%.
The rent would be subject to tax at the landlord’s marginal rate. The dividends received by the pension fund from the equity portfolio would come with a tax credit but this would be non reclaimable. Any income “drawn down” from the pension fund would, of course, be taxed in full as pension income.
Of course, in comparing the likely overall return, there’s also the chance of capital growth in the property to take into account – but so would there be if the fund were left in a diversified fund inside the pension.
So, a potentially good idea in theory but in practice, perhaps not so. Either way, advice will be essential.
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