Investing in a pension could now double the returns of bricks and mortars over 20 years as a direct result of the unfavourable tax changes affecting buy-to-let landlords.
Research by online investment company IG found that investing £200,000 into a buy-to-let property could see your money grow by 237 per cent over two decades once capital gains tax is taken into account.
However, a 40 per cent tax payer could see potential returns as high as 435 per cent if they put the £59,700 sum needed for a deposit on that property into a tax efficient self-invested personal pension instead.
The appetite for buy-to-let loans has waned since the controversial hike in stamp duty surcharge to 3 per cent on second and subsequent properties came into play in April 2016
The number crunching assumes the investor takes out a 75 per cent loan-to-value mortgage and stumps up an initial £59,700 for the 25 per cent deposit and additional purchase costs, including stamp duty.
The research factored in average house price growth of 4.5 per cent a year over the two decades, plus a rental yield of 3.5 per cent a year.
The total return after costs factored in for the investment portfolio was lower, with an assumption that the pension pot would generate an annual growth rate of 6 per cent after fees over two decades.
That total return figure for pension remains generous, although the broad global MSCI ACWI stock market index has returned 7.4 per cent a year since its inception in May 1994.
The findings take into account the upcoming changes from the Government to taper tax relief on buy-to-let mortgage interest down from a landlord’s marginal rate of income tax, replacing it with a 20 per cent tax credit by 2020.
The critical change this triggers is how landlords report their income – in the past they’ve had to pay tax on profit after cost; following the changes, the must pay tax on revenue – eating into many landlords’ profit significantly.
IG’s research also factored in the introduction of a 3 per cent stamp duty surcharge on second homes and the removal of the automatic 10 per cent wear and tear allowance last year.
Oliver Smith, portfolio manager at IG, said: ‘There is a stark contrast in the tax treatment of a property versus a pension, with pensions winning out by a clear mile. The recent tax changes on buy-to-let properties will make a huge impact on the potential for long-term returns.
‘While these changes are only being fully introduced in 2020, a chill wind is already sweeping through the buy-to-let industry.
Buy-to-let properties were viewed as a good retirement income solution in the not too distant past but unfavourable changes to the landscape tarnished return potential
‘Savers need to remember that every pound spent on purchasing a buy-to-let property is paid out of net income and the tax changes mean that if financing costs rise, landlords will have to shoulder higher costs and consequently receive a lower net of tax income on their properties.’
The study does not paint a pretty picture for buy-to-let. IG calculated that a modest increase in mortgage costs of 1 per cent through gearing – the act of borrowing to increase returns – could result in an investor’s total return falling from 237 per cent over 20 years to just 60 per cent.
Buying a property with a view to letting it out to provide an income in retirement was an appealing option in the not too distant past – especially as paltry annuity rates and high investment charges put pressure on the chance of earning a decent income from pensions.
But a lot can change in a short period of time – and a lot has.
The advent of the pension freedoms, which removed the requirement for individuals with a defined contribution pension to purchase an annuity at retirement opened up a plethora of investment solutions for latter life income.
The National Landlord Association has now said the plight of landlords suffering from recent fiscal changes could create the ‘next pension crisis’ as individuals are becoming over-reliant on property to fund their retirement years.
The landlord trade body’s own research found more than three quarters of landlords in Britain admit to being reliant on their buy-to-let property to fund their retirement.
This is supported by findings of a separate report by Mintel which found that almost seven in 10 people believe that buy-to-let is a good vehicle to save for retirement savings.
Richard Lambert, chief executive at the NLA, said: ‘As a consequence of Government policy over recent decades almost two million people are reliant on their property to fund their later years, but the changing tax regime will substantially reduce the income they receive from these investments and so compromise the retirement plans of a significant number of hard-working people.’
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