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What Are Your Retirement Plans Built On?

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Annuity and savings rates are low while property prices and rental yields are high.  As a result, buy-to-let properties are becoming more common place as part of a retirement plan.  Whilst this can be a good strategy, it is important to understand the risks as well.

The number of buy-to-let mortgages has increased by nearly 50% since 2007. Demand for rental homes is strong as many aspiring buyers have been unable to get on to the property ladder, they are renting instead.  With rental yields consistently beating inflation, more people are considering a buy-to-let property as a supplement to their income.

It’s important to understand any investment and not to overlook the risks. There is often an assumption that property values always increase.  Recent experience should have taught that prices are cyclical so property has to be seen as a longer term investment.  

The annual costs of property ownership are often under estimated: letting agency fees, insurance, maintenance costs, renewals of carpets, kitchens etc.  as are the effects of ‘void’ periods when rental income will dry up.

There is also the risk of tenant default, whether failure to pay rent or breach of obligations to take care of the property.

The tax position is not always understood.  Rental income from a buy-to-let property is subject to income tax which needs to be declared in your tax return each year and, when you come to sell, any increase in value may lead to capital gains tax at either 18% or 28%.  Capital gains tax can eat in to more of the profit the longer the property is held because the annual capital gains tax allowance cannot be rolled over from year to year.

Property investment does make sense for those who can afford to get into the market and who understand the risks involved.  It should not normally be the sole strategy. Diversification is always important in managing wealth. 

I met a couple recently who had four buy-to-let properties and wished to retire.  All four properties were vacant because they needed to upgrade the quality of the kitchens and bathrooms to attract tenants, who were demanding higher standards due to having a wide choice of properties to choose from.  Needless to say they could not retire and had to continue working to finance the improvements and pay the mortgages.

Contrast this other forms of saving and investment.  A pension offers diversity of investment from cash, to property to shares. It also offers access to global investment including the emerging economies of South America, Russia and Asia.

Contributions to a pension attract tax relief at 20% and higher rate tax payers can claim a further reduction in the amount of tax they pay, up to certain limits.  For example an investment of £800 into a pension plan will attract a payment into the plan of £200 from HMRC straight away.  That is an immediate 25% return! In a pension, your money grows virtually free of tax. When you draw your pension, 25% of the fund could be returned to you as lump sum with no tax to pay.  The income could then be guaranteed to continue for life whereas rental income, as noted above, is not guaranteed!

Using ISA allowances is another tax effective means of building up retirement funds.  Each UK individual can save £11,520 each year (either the whole amount in a Stocks & Shares ISA or up to half (£5,760) in a Cash ISA and the remainder in a Stocks & Shares ISA) and there is no tax to pay on either income or capital withdrawn.  ISAs can invest in global markets and it is relatively easy for your financial adviser to move monies around to suit your risk profile and investment preferences.

If you wish to discuss your retirement or savings options, Graham Westhall at SWLaw Investment and Financial Planning Ltd will be pleased to offer you a free ½ hour consultation. Graham is a chartered financial planner with over 25 years’ experience of financial services.