Scrutton Bland directors Gary Riches (Independent Financial Advice) and Gavin Birchall (Tax) take a closer look at pension freedoms
Since April 2015, many individuals have been tempted with early access to their pensions, with the relaxation for accessing pension funds often referred to as ‘pension freedoms’. £2.5 billion was withdrawn from pensions between April and June 2015 according to the Association of British Insurers. However some of the adverse tax consequences, which are surprisingly high, are less well known.
Pensions have been accessed for various reasons, but some of the interest has been with a view to investing in buy to let residential investment property, which currently cannot be held within a pension fund. This interest is generally not due to a desire to become a landlord, but is largely driven by low returns from cash accounts and historically better returns from growth and rental income from property.
In general, after payment of tax free cash, the remainder of funds withdrawn is taxed as income, and depending on total taxable income, the cash from the pension fund can be taxed at 40 percent or more. With the loss of personal tax allowance above £100,000, the funds can suffer tax as high as effectively 60 percent.
The headline returns from property investment may be high but they may not fully reflect all aspects of taxes and other costs which need to be considered.
Taking an example of a £150,000 pension pot, assuming tax free cash at £37,500, the balance would be taxed as income. Assuming no other taxable income, the tax would be £36,903 and the pension capital, after tax would be £113,097. Assuming a very high buy to let property yield of 7.5 percent, rent would be £8,482 before tax. Comparatively the fund, if left within the pension, would not suffer the tax deduction so would require a yield
to provide the same gross income of only 5.65 percent.
Other factors to consider are legal and other costs in purchasing the property, possible additional borrowing and borrowing costs and a managing agent may be used, incurring fees which further impact on rental income, as will provision for repairs.
As well as costs there are other important tax factors to be considered such as Capital Gains Tax when a property is sold and possible Inheritance Tax on death. The Government have also made announcements regarding taxation restrictions on buy to let property relating to interest on borrowings, further reducing the tax efficiency of property investment for higher rate tax payers.
Apart from financial considerations, investment in a buy to let residential property may require the investor to take on day-to-day responsibilities such as property maintenance and rent collection, which may well not be wanted in retirement.
The ‘unaccessed’ pension by comparison, will grow free of Capital Gains Tax; a quarter of the fund is available tax free and a lower or zero income tax rate if gradually drawn.
Pension income will be regular and can be guaranteed for life or joint life and unlike property investment would not suffer periods of non-occupation with a loss of rental income. Alternatively pension incomes can be drawn with flexible payments.
When a person dies his or her pension funds are often considered to be ‘lost’. This is generally not the case as the pensions can pass free of any tax on death under the age of 75 (meaning no Capital Gains, income or Inheritance Tax). Death over age 75 incurs 45 percent tax until 5 April 2016, reducing thereafter.
In summary, with taxation improvements in pensions and the adverse tax position of using pension for property investment, great care needs to be taken when cashing in pension funds.
With future reductions in pension tax relief for high earners and reductions in lifetime allowance, it is important to seek advice from an independent financial adviser when deciding upon the type of pension in retirement.
For further details or to arrange a meeting, without obligation to discuss your pension arrangements as part of a tax-efficient strategy, contact: