Why the Autumn Statement was so important for pensions

sausage_link Brick

Last Thursday I pointed out how the introduction of a Stamp Duty Land Tax (SDLT) could be the most significant statement on pensions that Osborne never made.

Paul Lewis has blogged the details, follow his twitter timeline to see the Q&A from his readers, it shows how people are waking up to the importance of this new tax


 

This is how Ian Cowie puts it in the Sunday Times ..

The tide is finally turning against property in favour of pensions after the chancellor targets the burgeoning buy-to-let market

I am not a fan of buy-to-let investment. It frustrates first time buyers by putting up the prices of reasonably priced flats and concentrates housing wealth in the hands of a few. It is  “anti-social housing”.

Nor do I like the impact that it has had on the pensions market. The get rich quick brigade have shown that you don’t have to save prudently for your retirement, you just need to have a portfolio of properties which you can buy and sell with impunity of taxation. There has been an implicit bias in the housing taxation laws towards buy-to-let for as long as I can remember. Buy-to-let has been burgeoning for decades –

“we all live in a Robbie Fowler house”.

This bias has not just led to a fair number of people ignoring pensions in favour of buying houses to let, but envy among those who do not have the capital, but see themselves having to use pensions as a second best. I have lost count of the number of times at pension seminars, that people have told me their house is their pension.

“You can’t buy a sausage with a brick”

Despite the mechanisms of equity release or “last-time buyer mortgages” – as L&G terms it, most people do not sell their homes and trade down to more appropriate later life accommodation. The housing stock that should be passing through the generations is not. This is another impact of the skewed taxation system that promotes property ownership above all other forms of private wealth. Our homes are our castles, even if we can’t afford to heat them.

I hope that the Chancellor’s announcement will lead to a proper public debate about the state of the UK residential housing market and the issues relating to liquidity which lead to so many of us being property rich- income poor.

The Daily telegraph are taking quite the contrary view to mine and see SDLT as one in a string of attacks on vulnerable landlords whose Rackmanite dreams are now being thwarted (well I never claim to be balanced!). The Telegraph view is available here!

 

What I hope will happen

I hope that people will make an analysis of the tax treatment of a buy to let investment. Here is such an analysis which leads the blogger – in this case top IFA Darren Amos to the conclusion that tax is ringing the death knell for buy -to-let. here’s that analysis.

The Chancellor of the Exchequer has announced several changes that will dramatically change the world of Buy to Let property investment when they are implemented from April 2016.

In summary these changes are as follows:

  1. Restriction of Tax relief to Basic Rate only
  2. Increase in Stamp duty by 3% above equivalent residential property
  3. Requirement to pay any Capital Gains tax due on sale within 30 days

Taking these changes into account, we have to ask several questions.

Is Buy to Let still a good idea for a Higher rate taxpayer?

Should advisers still be encouraging clients to consider this as an Investment option, or recommend alternatives?

Probably most importantly, is it a sound way of generating an Income?

Let’s look at a typical scenario for a property BELOW the stamp duty thresholds.

£125,000 property with £100,000 Buy to Let mortgage

Current situation

Rental income at £600 pm £7,200 pa

Repairs & other allowable expenses (£1,000)

interest on mortgage (£5,000)

Net taxable profit £1,200

Tax @ 40% £ 480

Net return £ 720

This equates to 2.88% on the £25,000 capital employed

Under new rules for Tax relief

Rental income at £600 pm £7,200 pa

Repairs & other allowable expenses (£1,000)

interest on mortgage N/a

Net taxable profit £6,200

Tax @ 40% £2,480

Less Interest tax relief (20% of £5,000) (£1,000)

Tax due £1,480

This reduces the Real Return in this case to less than zero!

Rental £7,200

less mortgage (£5,000)

less allowable expenses (£1,000)

less Tax (£1,480)

Net return (£280) loss

This equates to minus (1.12%) on the £25,000 capital employed

In order to make it break even the rental needs to be at least £625

Many people might still see this as a good idea, relying instead upon the Capital growth over time.

Let’s assume that the property grows at 3% pa average for the next 10 years and then they want to sell. The property will have risen to about £168,000, making a £43,000 gain. Assuming cost of sale as £3,000, and Capital Gains Tax allowances of £12,000 approx the taxable gain is £28,000.

This is taxed at 28% (£7,840) leaving a net gain of £32,160

Still not bad, but other options are probably simpler & the capital is more easily accessible.

Best of all, they are less likely to have tenant issues!

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Now, let’s look at a typical scenario for a property ABOVE the stamp duty thresholds.

£200,000 property with £160,000 Buy to Let mortgage

Current situation

Rental income at £1,200 pm £14,400 pa

Repairs & other allowable expenses (£ 1,700)

interest on mortgage (£ 8,000)

Net taxable profit £4,700

Tax @ 40% £1,880

Net return £2,820

Less Stamp Duty paid (2% of £75,000) (£1,500)

Net return in year 1 reduces to £1,320

Under new rules for Tax relief AND Stamp Duty

Rental income at £600 pm £14,400 pa

Repairs & other allowable expenses (£1,700)

interest on mortgage N/a

Net taxable profit £12,700

Tax @ 40% £5,080

Less Interest tax relief (20% of £8,000) (£1,600)

Tax due £3,480

In this scenario they do still manage to actually make a net return

Rental £14,400

less mortgage (£8,000)

less allowable expenses (£1,700)

less Tax (£3,480)

Net return £1,220

However, we still need to deduct the new levels of Stamp duty

Less Stamp Duty paid (5% of £75,000) (£3,750)

Net return in year 1 reduces to (£2,530) loss!

In fact no profit is made for the first three years

 

By breaking the magic mantra, that property ownership is tax-priviledged, the budget has taken a first step in the right direction.

What I hope will happen is this

  • People will start saving for their retirement , rather than borrowing to buy to let
  • People will increasingly think of their homes as a place to live rather than a pension
  • Large institutions, especially the funds into which we invest for retirement, will replace private landlords, enabling people to think of trading down in later life, thus freeing up the housing stock for young families.

The start of something big?

A lot of small announcements trigger huge social change. I hope that the small announcement on SDLT will be one. We do not think about where the money we invest for the future goes – ETFs and Index-Tracking Pooled Pension Funds don’t do it for people. People like to know what is happening to their money and have a sense of ownership. We call this PROPERTY RIGHTS for a reason.

Because people have had no property rights from their pension funds, they have chosen to invest directly – in property.

 

Making our pension property rights- vivid and real.

But if people realise that direct investment in property, is subject to the same gravitational pull (the only certainties are death and taxes and death taxes) then they might start thinking about more sophisticated forms of ownership. Necessarily the ownership of the means of production – our quoted companies, their debt and the infrastructure that makes this country work.

In order for people to want to invest in pensions, we need to make Pensions “property funds” – that doesn’t mean investing just in residential properly, but it does mean making people’s ownership rights , in the funds in which they are invested, more vivid and real.

If he can make the connection between pensions and later life freedom as real as the connection between mortgages and the keys to your house, Chancellor Osborne really will have done something.

mortgage loan agreement

Making it vivid and real

 

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Why the Autumn Statement was so important for pensions

  1. bobchampion says:

    Henry,
    We have built too few houses and either because of the housing costs we incur as a result or for other reasons we have saved too little into our pensions.
    I look at a person retiring from a job paying an average wage, with an average pension pot (around £30,000) and ask how are they going to have a reasonable retirement unless they tap into any housing wealth they have accrued?
    Whether we like it or not , it will be many years before any policy changes made today will have a significant impact on the average person I describe above.

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