The ink on the Chancellor’s Budget had hardly dried, as people began to speculate the proposed changes to pension rules, would mean more people jumping on the Buy to Let bandwagon.
In fact, you could almost feel some estate agents get giddy with excitement, at the thought of a new market to take advantage of.
But will this really happen? Are people better off with a property investment than an Annuity? Is Buy to Let the solution to people’s retirement income needs?
We’ve crunched the numbers for you and here are the results.
Firstly a quick reminder, what’s changed?
From 6th April 2015 it is proposed that anyone with a defined contribution pension, such as a Personal Pension, Stakeholder Pension or Self-Invested Personal Pension (SIPP) will be able to take up to 25% of the pot as a tax-free lump sum and the balance also as a lump sum, which will be subject to tax.
Previously, the 75% of the fund not taken as a tax-free lump sum had to provide an income.
Some industry commentators have suggested that the ability to take the entire fund as a lump sum, will tempt people to withdraw as much as they can and invest in a Buy to Let property, to fund their retirement.
But we’re not convinced the maths stack up, here’s why.
What income is available from a Buy to Let?
We’ve made some assumptions in our effort to answer this question:
- We’ll assume the pensioner has a pot of £100,000 and is a 20% taxpayer with other income of £10,000 per year
- If 100% of the pension is taken as a lump sum, the net amount after tax, to buy a property will be £76,273
- After fees let’s say the purchase price is £75,000 and we’ll assume a gross rental yield of 6% (Source: Paragon Mortgages)
- We then need to deduct an amount to cover fees, such as agency costs, insurance, safety certificates and void periods, this could come to 20% each year, perhaps even more, reducing the yield to 4.8%
This means the income, before tax, but after costs, would be £3,600 or £300 per month.
How does that compare to an Annuity?
Let’s take a typical person retiring at age 65.
They can buy an Annuity with the full £100,000 fund; in reality they would probably be better off using the 25% tax free lump sum to buy a Purchase Life Annuity (PLA) and the balance a Lifetime Annuity, but let’s keep it simple.
The £100,000 pension fund would generate £5,613 per year assuming the retiree was 65, bought a level Annuity, their spouse was three years younger, and a joint life Annuity is purchased, with a five year guarantee and 50% spouse’s pension.
Those figures could increase significantly if the pensioner qualifies for an Enhanced Annuity, but again, let’s keep it simple.
How do the figures compare?
On our hypothetical assumptions the Buy to Let would provide an income, before tax of £3,600 each year, however the Annuity produces £5,613; some £2,013 more each year.
The income from the Annuity and the Buy to Let are both taxed in the same way.
Over a typical 20 year retirement, that could mean an extra £40,000 income from the Annuity.
What other factors do we need to think about?
On the face of it the Annuity wins hands down, but what other factors do we need to take into account?
Income guarantees The income from the Annuity is guaranteed, clearly the rental income is not and could be further eroded by unforeseen maintenance work on the property or longer than expected void periods
Capital value There is no opportunity for capital growth on an Annuity, when you’ve handed over your money its gone.
This isn’t the case with a Buy to Let property, it could rise in value, equally it could fall.
Furthermore potential Buy to Let investors need to be careful of buying at the top of the market; according to the Halifax House Price Index the value of property has risen by around 10% over the past 12 months.
Buyers also need to consider the potential for interest rate rises in 2015 and 2016, which could push house prices down.
Of course the counter argument to this is that Buy to Let should be seen as a long-term investment.
Inflation We used a level Annuity in our example, simply because that’s what most people buy. This means the income will never rise and the buying power will be eroded each year by inflation.
With a Buy to Let property the owner can build in an annual increase to the rent to offset the effects of inflation, that assumes of course that the tenant is willing to pay a higher rent!
Liquidity An Annuity offers no liquidity whatsoever, it is a one off decision to purchase with no ability to perform a U-turn.
A Buy to Let property offers more liquidity; obviously a buyer needs to be found, costs will be incurred and there may be tax to pay if the property has risen in value, but nevertheless, it can be sold and the value realised.
Inheritance Whilst the income from an Annuity can continue to your spouse or partner, that’s it, when you have both died, any income will stop. Furthermore, the spouse’s pension you built in when you set up the Annuity may be at a lower level to the income you enjoyed.
This isn’t the case with a Buy to Let, which can be left to your beneficiaries on your death.
Simplicity v complexity Once you have bought an Annuity it is a relatively simple product, the same cannot be said of a Buy to Let, which needs constant attention.
Annuity or Buy to Let, which is better?
Whilst a Buy to Let property may well work for some people, we don’t believe, in the majority of cases, taking money from a pension is a sensible option:
- The tax payable when the entire fund is withdrawn could be significant
- The income generated from the Annuity is likely to be significantly greater
- The typical Annuity purchaser is attracted by the guaranteed income and simplicity of the product, neither of which are available from a Buy to Let investment
Of course Buy to Let has a couple of advantages, particularly in terms of potential capital growth and the ability to leave it to your beneficiaries; we just don’t believe in most cases taking the money from your pension is the way to fund it.
We are here to help
If you would like to know more about how the Budget will affect you and your pension our team of advisers are here to help.