Can I draw out my pension and buy a rental property?
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The short answer to this question is yes. Essentially, anybody over the age of 55 can draw out their pension and buy a rental property.
The issue comes when you decide whether this is actually something that’s going to be suitable for you to do, after you take into account your personal circumstances. There are also large tax implications involved with drawing out your pension funds to buy a rental home, which can make the proposition unattractive.
How do you purchase a property with your pension fund?
Let’s say you have a set amount in your pension fund that you want to use to spend on a rental property.
As a first step, it’s a good idea to establish whether the money you have available to you is going to be enough to buy something in the area you desire. You also need to consider the other costs that you incur when you buy a house; such as solicitors, mortgages and stamp duty.
For example, let’s say you are cash buying a rental property. You will need to consider the likes of solicitors fees and you will also have to pay a stamp duty surcharge, which is levered on any property that you’re buying to let out or any second property and is 3% of the purchase price:
- Let’s say the property you’re looking to buy is priced at £105k
- Solicitors fees for this are likely to be around £1200k
- Stamp duty would be £3,150k (3% of the property price)
- Total costs would be £4,350k
With the above example taken into consideration, it’s important you ensure you draw enough from your pension pot to cover the additional costs alongside the amount it’s going to cost you to purchase the property in the first place.
What return will you get from your rental property?
If you’re drawing money from your pension pot to spend on a rental property, you want to ensure it’s going to provide you with a healthy return to make it a worthwhile investment. How much return you get will largely depend on the area your rental property is situated.
You also need to consider costs if you decide to use a letting agent to rent the property out, which is usually around 8-10% of the rent you charge your tenants each month. You will also need to ensure any maintenance costs are covered with the property and that you also have sufficient buildings insurance in place to ensure your property is protected.
What income should you expect if you don’t take the funds from your pension?
With any pension pot, you can withdraw a certain amount as a tax free, lump sum. Once this has been withdrawn, you can use the money you’re left with to generate an income.
This can be done through two main routes; an annuity or a drawdown.
An annuity gives you a guaranteed income for life, but it does mean you have no access to your capital. With a drawdown, your income isn’t guaranteed but you still have access to the capital and any unused funds you haven’t drawn upon can be passed on.
Is it a good idea to use your pension to purchase a buy to let property?
Your pension is so heavily taxed when you withdraw it and you then have to pay tax on the rental income – so depending on your personal financial position it’s not necessarily the most tax efficient way to get your pension to work for you.
Property is a great investment to have in your portfolio, but we believe it should compliment your pension fund rather than strip it out entirely.
Why do people value a property purchase more than their pensions?
We believe people feel that they understand property a lot more and it’s a tangible investment they can make, whereas with pensions, people can feel a bit more out of control. Generally, pensions are made up of a mixture of investments that tend to be linked to the stock market – which people deem risky and complex.
Pensions are deemed as higher risk because their value can fluctuate day to day. Whereas with property, although the value can increase or decrease, this generally happens over a prolonged period of time.
People see property as a safer investment but you can also stumble across a lot of risk, such as not actually receiving any rental income and spending the money you’re earning from the rent to maintain the property building.
You could achieve the best of both worlds and purchase a buy to let property using your pension pot, but doing so by withdrawing your tax free amount from your pension and using this to put down a deposit on a buy to let mortgage. This way, you are retaining the rest of your pension pot that provides you with an income, while potentially generating another income through a rental property using your tax free lump sum.
How Do We Help?
As part of our Wealth Management services, we can assist in building you a Bespoke Retirement Plan, whether your just starting out, or trying to make sense of your existing position, we will work with you, to establish the income you need and what you need to do to achieve your required goals.
We offer an initial meeting at our cost, to complete an overview of your current position, and establish what work and research is required, detailing clearly costs involved if you want us to provide you with a recommendation, and go onto implement our advice, and become a client. On becoming a client, we will then keep track of your retirement plan, by managing your pensions or investments through regular contact and annual reviews.
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What are the options for income in retirement?
In the last five years, we’ve seen a massive shift in the way that people are taking income in retirement. Back in 2015, pension freedom was brought in, which gave people a lot more flexibility as to the way they access their pensions.
Traditionally it was the case that you either looked at an annuity model, which provided a guaranteed income for life but was quite inflexible, or you had capped drawdown, which meant you could draw down up to a certain level of income from your pension pot, which generally offered a lot more flexibility. Pension freedom scrapped all of that.
Effectively, now we have the option where you can still take an annuity if you want a 100% guarantee of what your income will be.
You can opt for flexible access drawdown, which means you can kind of dip into your pot as much or as little as you need. That carries the risk that if you take too much, you might exhaust the pot and run out of money.
Also, the actual freedoms did provide people the option to fully withdraw their pension pot, but, of course, that then doesn’t provide any income and it’s how you would then look at generating income from those funds.
What’s the most popular option at the moment?
This is a report from 2018-2019 by the Financial Conduct Authority. In that report, there were 355,000 pension pots that had been accessed, which 11% of people had taken annuity.
30% had gone into a drawdown arrangement. 4% had entered into a drawdown arrangement where they’d opted to take tax free cash only, but weren’t taking income.
55% of people had actually fully withdrawn their pension pots, which is just staggering given that your pension pot is obviously there to provide you income for retirement.
Are people aware of the tax implications on taking it all out?
Certainly there’ll be a percentage that are. A lot of people that had actually fully withdrawn their pension pot hadn’t looked to seek any advice prior to doing so.
To give you kind of a bit of an example, if you are still employed and earning a salary and, let’s say, your income was £20,000 a year, you have a pension pot of £50,000 and you decide, right, I don’t like pensions. I can’t access the money, doesn’t feel like it’s mine. I’m taking it all out, which is generally the thought process of quite a few people that take this route.
The actual tax that you would pay on that £50,000 pension pot would actually be a figure of £9,000, which, to us, is a staggering amount of tax to pay.
It’s then a case of what you do with that money. If you then take that £41,000 and stick it in your bank earning 1%, is that actually a good way to make your money work for you?
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Why are so many people not seeking advice?
Certainly, some people don’t necessarily value their pension and appreciate that it’s there to provide that retirement income.
Some people don’t like the idea of having to pay for advice in order to access their money.
Personally, if it is a case that you’re not taking advice, not understanding the implications, not looking at actually if you draw all that out, is it going to leave you in a position where actually you have no money to live in retirement?
That points towards the value of advice and making sure that such a big decision is not taken lightly.
When are people looking at their retirement income?
One thing we’re seeing with people is their retirement time frame is quite different.
We’ve seen the state pension age now move from 65 to 66. We’re going to see it increase to 67, 68, and who knows where we’ll see it go from there?
We’re tending to see a lot more people staging retirement. They might stop working full-time at 60 and do some consultancy work or some part-time work, so people’s flexible income needs between then and state pension age vary massively.
We’re seeing a lot more stages in retirement than traditionally we would have seen historically.
Are Annuities Good Value?
Overnight, the landscape changed and a lot of people just considered that, right, annuities are really poor value for money. They don’t offer any kind of benefit.
For the right type of person, an annuity is definitely still a way forward.
There are still short-term options. I think there’s also a myth that if you have an annuity and you die, then you don’t see the value out of your pension. Again, that’s not quite the case because you can build in protections into an annuity so if you were to die early, there would still be value to take out of it.
The negative of that though is the more add-ons you build into annuity, it then starts to impact the income that you personally receive.
It’s quite a complicated decision to make.
What Does Drawdown Mean?
Flexible access drawdown basically means that you can choose to withdraw as much or as little from your pension pot as you want.
Drawing too much obviously can have long-term impacts. Certainly when we are planning, we’re looking at the short-term income need, but also balancing that off against the long-term.
The other elements we look at is also trying to make any draw downs as tax efficient as possible.
If we can try and set pension drawdowns within just the basic rate tax environment and there are further shortfall needs, we can then maybe start to look at investments.
Every client is extremely individual and our main aim is to produce the income they need from what they’ve got in the most tax efficient way possible.
Flexible access drawdown allows us to do that, because we can increase and decrease the income levels depending on the need in a set period of time.
What happens in a pension review meeting?
In an initial meeting, it’s very much around trying to get to know the person and understanding what their dreams are and how they view retirement.
Quite often, there is this staged look towards retirement and it’s then looking at, okay, well, in those stages, what are our income shortfalls going to be? What do we need to do to fill those gaps for them?
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
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