Buy-to-let has been widely touted as a way for new retirees to make their income. Having full access to your pension make the prospect more realistic – on paper, anyway. But there are numerous factors you should consider first before entering the rental market.
We in the UK seem to have an undying faith in the property market. No sooner was pension freedom announced than many pensioners started looking into the prospect of becoming ‘silver landlords’. So is buying to let the future of retirement? Before you cash in your pot for a property portfolio, here are some points to consider.
1. Property is expensive. How big is your pension pot?
The average price of a flat in England and Wales is now around £250,000. Even if your pension pot is around that size (most aren’t) you’re unlikely to want to spend it all on one asset. This means that you’ll almost certainly need a mortgage as well. Which brings us to point 2…
2. Can you get a mortgage?
With a large lump sum from your pension, you should be able to put down a large deposit on the property you want to buy, and lenders will like that. However you will still need to borrow the remainder of the money. Your high loan-to-value ratio could help you to obtain a low interest rate, but the lender may have concerns about your ability to keep up repayments. Fortunately, the age limit for some mortgages has risen to 85 – but will you have enough dependable income to do this? You may reply that it will come from the rent, but your lender knows there will probably be times when the property is unoccupied, so is unlikely to accept this if it’s your only way to pay.
3. Do you have any other sources of income?
Before granting you a mortgage, a lender will want assurance that you can keep up repayments even during the times when your property is unoccupied. This means you will need another source of income too, such as investments or annuities, to tide you over any shortfall. This is not just to cover mortgage repayments but also your everyday living expenses – remember that an empty property will turn from a source of income into an additional expense. What this means is that you shouldn’t sink all of your pension savings into a property, but keep some in reserve. This makes property investment even more of a challenge unless your pension pot is especially large.
4. How much tax will you have to pay on your withdrawal?
This is potentially the biggest obstacle of all. Although pension freedom will give you access to your whole pension pot, income tax still applies. Although 25% of your fund can be withdrawn tax-free, after that you will pay 20% tax on any withdrawal up to £31,785, then 40% tax on anything up to £150,000 and so forth. This could potentially wipe out a substantial chunk of your pension fund before you even get started. After a lifetime of saving tax-efficiently, would you really want to do that?
5. Have you factored in the additional pressures on landlords?
For any property that is not your main residence (e.g. rental property) you have to pay an extra 3 per cent in stamp duty land tax. This will be an additional expense initially.
Furthermore, landlords can only claim tax relief of up to 20 per cent on mortgage payments. This is find if you are a basic rate taxpayer, but if you are a higher rate taxpayer this will further eat into your profits going forward. You can find out more about that here.
6. What will your overheads be?
A first-time landlord may have a vision of sitting back and letting the money roll in. As any experienced landlord knows, the reality is rather different. You are responsible for repairs and maintenance on the property, regular redecoration, building insurance, energy certificates and gas safety certificates. Acquiring tenants is also a cost, and if you are unlucky enough to get a rogue tenant, legal costs can be a major unforeseen expense.
Also, we’re not yet done with tax. You will have to pay income tax on the rent you receive, and if you’ve already withdrawn a large sum from you pension (to buy the property) you could end up paying higher or top-rate tax on that income in the first year.
7. Are you comfortable with performing the duties of a landlord into your later years?
Look again at the list of things in point 5. Do you want to still be doing that when you are 80? If not, you will have to pay someone else to do it – yet another expense.
8. Have you thought about inheritance tax?
A potentially huge drawback is inheritance tax (IHT). Remember that, under pension freedom, your pension fund can be passed on to beneficiaries free of tax. This is not true of property, which is vulnerable to IHT – a potential 40 per cent loss on its total value (not just the growth or profit). This mean that your buy-to-let property would need to grow in value by a staggering 67 per cent just to break even, once you take IHT into account.
9. Will your property make you more than your current pension investments, taking all other costs and tax into account?
When weighing up any financial decision, one question should be foremost in your mind: will this make me more money than what I’m doing at the moment? Fiona Tait from Royal London is concerned that people are not thinking this issue through. She says, ‘If you choose to take your money out of one investment – any investment – and invest it in another, you would want the second investment to at least have the potential to provide a better return over and above the costs of investing.’ When you take into account all the expenses listed above, it’s clear you would need to make a very high rental income to make up for the costs of setting up as a landlord. Of course, you still have the property itself which may rise in value, to be sold at a profit in years to come. But that chunk of money doesn’t help you very much now, as property isn’t a liquid asset that you can just dip in and out of. Also, you will have to pay capital gains tax on any gain in value when the time comes.
This does not necessarily mean that becoming a ‘silver landlord’ is a bad idea. But anyone considering that route in retirement should bear these points very carefully in mind. Unless you have a very large pension pot and can diversify into other investments as well as buy-to-let, the landlord strategy may be impractical or simply too risky for you. The best way to be sure if a retirement plan is right for you is to seek independent financial advice – after all, not every pensioner wants to be called out to deal with rising damp.
Making retirement plans? Get started with a free pension check from an adviser near you, with £50 off any follow-up advice.