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Pension freedom reforms allowing over-55s to access all their savings for old age in one go from next April will abruptly make this an affordable opportunity for a lot more people.

But if you’re among those weighing up the prospects of buy-to-let investing, then watch out for the taxman because he will extract a high price.

What will people do with their pension freedom?

More than one in 10 people plan to grab their entire lifetime savings and some 16% of those people want to reinvest in property, according to recent research.

The chance to speculate in the housing market beyond simply owning your own property, and take a regular income from tenants at the same time, is bound to seem attractive when interest rates are low and equity investments are volatile.

 Buy to let properties - 78009726CF001_PARAGON SHARES

If enough retirees feel this way, it could mean another buy-to-let boom is on the way after the pension freedom reforms kick in next year.

But those who make this choice face a big tax bill, even if it won’t be as much as it is at present. Over-55s are currently charged 55% tax if they withdraw their whole pension pot.

From April 2015though, 25 per cent of the pension fund taken out will be tax-free and the rest taxed at the plan holder’s marginal rate. But this means that if you take a substantial sum at once, people who pay tax at the basic rate of 20 per cent could suddenly find themselves in the higher-rate 40 per cent tax bracket.

It is estimated that people will end up handing over more than £1.6 billion to the Treasury.

Three ways to invest for income in retirement – and the taxman’s take

To illustrate the potential impact of tax, we analysed how three separate retirement income strategies might fare over a 20-year period.

The three scenarios all involve someone with a £300,000 pension pot looking to preserve capital and make a sustainable income. They are:

1) Buy Property: Take all the money in one go, paying tax on 75 per cent of it, reinvest in a property, live off the rental income

2) ISA’s: Take all the money in one go, invest in equity funds and progressively reinvest in ISA’s, taking an income from the underlying funds (taxed) and the ISA’s (tax free)

3) ISA and income drawdown: Take just the 25 per cent tax-free lump sum, invest it progressively in an ISA, and leave the balance of your fund in an income drawdown scheme, taking an income from both the ISA and the drawdown.

The results show that it is clear that paying tax upfront for accessing all your retirement savings is a significant drag on your potential future returns. 

 

The impact of differing retirement

income strategies over 20 years

 

Capital Value

Net Annual Income

Total Income Received

Property

£362,053

£8,689

£137,964

Invest and ISA

£368,416

£14,737

£218,406

ISA and Drawdown

£541,610

£15,162

£239,291

*Assuming standard growth rates and based on a 20% tax payer.

 It should be noted that after 20 years, a very significant gap has developed in income payments, because the ISA and drawdown options have both gained from beneficial tax treatment. With ISAs, no tax is deducted from income payments, and with drawdown, no tax is deducted from your fund at the start.

The tax benefits of pension funds have been specifically designed to benefit those who use the funds in retirement to provide their income.

Taking all your cash out to invest in property is going to appeal to some people but it comes with a high price to be paid to the tax man.

Anyone considering taking advantage of the new pension freedoms to invest in property should first look very carefully at the tax implications.

If you would like to know more about the Pension Freedom Reforms, or would like to discuss your own personal circumstances, you can arrange an appointment with one of our Independent Financial Advisers in the ‘Contact us’ section of this site.

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