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Tony Wickenden: Budget buy-to-let investors could be disappointed

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It is an understatement to say that this year’s Budget contained a few surprises. Without doubt the biggest for the financial sector and the country at large were the proposals to seriously relax the rules on withdrawing benefits from defined contribution registered pension schemes. 

Broadly speaking, the Government has made the following immediate changes to the current drawdown rules. For drawdown years commencing on or after 27 March 2014, the maximum capped drawdown income that can be taken in each drawdown year will be increased from 120 per cent to 150 per cent of the relevant annuity. 

It should be remembered that the legislation only sets out the maximum allowable capped drawdown income. It will, however, be for providers to decide whether to increase the income to this new maximum amount. When the maximum drawdown was increased from 100 per cent to 120 per cent of the relevant annuity rate from March last year, some providers did not immediately allow the drawdown income to be increased to the maximum (then 120 per cent) level permitted by the legislation.

So much for the immediate changes. It is the proposed April 2015 relaxation, permitting unrestricted pension fund drawdown regardless of “pot size”, that has grabbed the headlines.

In connection with this, there have been more than a few predictions of a potential 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point that aside from the 25 per cent pension commencement lump sum tax-free cash, the remainder of the fund withdrawn would suffer tax at the “withdrawer’s” marginal rate(s) in the tax year of withdrawal.

If the investor had a fund worth £200,000, then £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 (after reduction of the personal allowance to zero) , then the remaining £150,000 would generate tax of £2,000 on £10,000 and about £57,000 on £140,000, leaving a net sum to invest of £50,000 (PCLS) + £91,000 = £141,000.

Then there is stamp duty on the value of property at 1 per cent on a purchase of over £125,000 up to £250,000 –  that is about another £1,400 gone, aside from any other expenses associated with the purchase.

And then, if a property can be purchased (with the tax-reduced sum) with a net rental yield of, say, (a high) 5 per cent the effective yield on the original £200,000 that could have otherwise been used to buy an annuity or remain invested to draw down from would be lower than 3.5 per cent 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 per cent. The rent would be subject to tax at the landlord’s marginal rate(s). 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.

Naturally, in comparing the likely overall return,  there is also the chance of capital growth in the property to take into account, subject to capital gains tax on realisation but “wiped out ” (for tax purposes with revaluation) on death. So, a potentially good idea in theory but, in practice, perhaps not so. Either way, advice will be essential.

Tony Wickenden is joint managing director of Technical Connection

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  1. On the other hand, many of these people might have been purchasing annuities – in which case they might have been bequeathing a 5 or 10 year guarantee to their dependants, rather than bricks and mortar.
    An offsettable five year capital repayment loan could be useful too – with PCLS up front and four tranches of £37,500 in subsequent years, the chances are that tax might be nearer £22,000 than the £59,000 suggested (even disregarding interest offset).
    Just cat-skinning again.

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