Tony Mudd: The dangers of buy-to-let pension investing


The Government has empowered a generation of retirees to do much more than they could before, including the idea of investing in the buy-to-let property market.

With meagre returns on cash savings, buy-to-let offers the potential for attractive levels of rental income and capital gains. Some retirees may feel they can tread a more familiar path by investing in bricks and mortar.

There is no doubt buy-to-let can offer some attractive upsides but investors who have saved diligently into a pension will baulk at the prospect of handing back 40 per cent or more in tax. Those who understand the need to maintain their standard of living throughout retirement will be working hard to minimise the tax they have to pay.

According to a recent Telegraph study, gross rental yields in some property hotspots can be as high as 7.6 per cent per year. As impressive as this sounds, however, buy-to-let is not necessarily the fail-safe investment opportunity these figures suggest. Many other factors need to be taken into consideration.

Tax tail

Residential property cannot be held in a pension; therefore, people purchasing a house or flat will firstly need to draw the required sum from the fund. The new rules make it possible to withdraw the whole fund, with 25 per cent available tax-free, but with further amounts taxed at the individual’s marginal rate of income tax. People taking a large withdrawal could, therefore, find much of it, along with any other income for that year, taxed at the higher 40 per cent rate or the top rate of 45 per cent.

The table below demonstrates the potential tax costs of withdrawing the entire pension in a single year, the rental income that could be achieved from the net proceeds invested in a buy-to-let property and the yield needed to achieve the same level of income if the whole fund remained invested in a pension.


The potential tax burden does not end there. If the value of the buy-to-let property rises sufficiently, it will be liable for capital gains tax when sold. In addition, any property owned by the individual forms part of their estate for inheritance tax purposes. There is then the business of appointing a letting agent, paying for repairs and working with tenants – all things people may not want to have to deal with as they get older.

In contrast, wealth held in a pension fund is remarkably tax-efficient for those who choose to keep it there. Investments are not liable to CGT while they are in a pension, regardless of how much they grow, and if an income is required from the pension, one can take flexible payments through the newly created flexi-access drawdown facility.

In addition to the tax-related issues one must consider, there are further downsides of investing in property that should be contemplated before making a decision. These include:

  • Investment of diversification: whether the purchase of a buy-to-let property, when taken together with the individual’s own home, over-exposes them to property investment.
  • The necessity, availability and attraction of borrowing to fund all or part of the investment.
  • The “hassle” of being a landlord; specifically the value of the individual’s time.
  • The actual returns net of maintenance and repair costs, letting and/or managing agent costs and taking into account periods of time when the property is not let.

Meanwhile, whereas property counts towards the value of an estate for IHT purposes, pensions do not. A pension can even be passed on to beneficiaries tax-free if you die before age 75. If death is later than this, income from the inherited pension is taxed at no higher than the beneficiary’s marginal rate of income tax.

Tony Mudd is divisional director, tax and technical support, at St. James’s Place