Phil Billingham takes a look at the scenario where people use the new pension freedoms to buy up a property for let and tells advisers it’s our job to make people aware and protect them from the circling sharks.
The press is full of it, and clients are already getting emails. In essence, it’s use your pension to buy a Property and let it out. Much better than one of those horrible ‘pension’ things. How can you lose? Hurray for pension freedom!
Well, as it says in ‘scoop’ (great book – worth a read) ‘To a point Lord Copper’.
Can we just row back a bit?
Firstly, unless you are going to get involved in timeshare and fractional ownership, we are talking about proper money here. I’d say £500,000 and more.
At that level, we can assume that the client is a higher rate taxpayer, and will probably have other assets.
So let’s run the numbers. Let’s see what this looks like.
If we accept the premise that pensions do and will perform worse than property, and that property can never fall – ‘iffy’ assumptions, but go on – then the simplified figures go something like this (I do have a detailed spreadsheet, but let’s keep it simple!)
£500,000 pension pot, assuming 6% gross growth, minus 1% fund and platform charges, and 1% adviser charge. A bit high, but OK.
Value of pot in 10 years is a bit under £770,000.
Instead, attracted by the publicity, we take the £500,000 and cash it in. That makes it worth £350,000, using the ‘tax free cash’.
Not great, but we are looking at higher returns. So 4% year on year compound capital growth and 5% income yields – both gross, but 9% total return as a starting point, 50% more than a pension portfolio.
Assuming that the client is a higher rate taxpayer throughout, and that the property is always occupied, and that there are never any capital events required (boilers, roof painting), there are no legal fees, there are no ‘void’ periods, that all tenants pay their rent and look after the property, and the property is sold at the imagined market value, then the net total value returned to the client – including income is… (drum roll) …. just under £533,000. So another £86,000 loss after the original £150,000 tax take.
In fact, the total tax take is close to £284,000, so the revenue will be supportive of this particular scam. Agents fees are chunky as well.
As a point of interest, any idea what the gross return needs to be for the Buy To Let to actually break even with the pension? A ‘critical yield’ if you like?
I imagined around 10%. I was wrong. Its actually 14.5%.
Can you imagine taking this plan to compliance for approval?
“I’ve got this great idea! We take a well diversified, flexible and secure portfolio, and cash it in. The client then pays 40% tax and then invests in a single asset which may well require him to add further funds, and take time to manage the asset themselves. There may be court costs involved at some point and we get to pay lots of agents fees and tax. And to match the boring, diversified portfolio, in a low inflation, low risk environment, this single, risky asset only has to grow by 14.5% every year to break even!! What a great wheeze!
Excuse me, why are you ringing the FCA……?”
In all the above I have ignored the effects of IHT. Promises have been made. They have been before. This time they may be kept. Who knows?
But the BTL is assessable for IHT, the pension is not. So if we look at IHT, then an additional 40% tax knocks us down to around £330,000 in total, including the net income received. A real and substantial loss after 10 years.
Emotionally, many clients will be vulnerable to this scam. And some will actually do OK from it. But the numbers are brutal for the majority. Our role must be to make people aware and protect them from the circling sharks.