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Tax impact of converting pensions into buy-to-let

This article is part of
Guide to Buy-to-let and Pension Freedoms

Pension savers can only take out 25 per cent of their total pension pot tax free, after which there is a tax burden.

If an individual uses their pension fund to purchase a buy-to-let property they will be subject to their highest marginal rate/rates of tax on 75 per cent of the pension fund, warns Tony Müdd, divisional director tax and consultancy at St James’s Place.

For example, he says a £200,000 pension fund would produce £50,000 of tax-free cash and £150,000 subject to income tax.

To work out the amount of tax paid, this amount will be added to their other income and, in this case, Mr Müdd says almost certainly a proportion of it will be subject to 40 per cent and perhaps even 45 per cent.

If we assume a blended rate of 30 per cent, Mr Müdd says this nets down to an investible figure of £155,000.

This £155,000 would have to work considerably harder in terms of producing an income than the pension fund monies of £200,000, he notes.

Furthermore, Mr Müdd says the income from the buy-to-let property is itself subject to income tax, whereas income could be drawn down from the pension fund in a way which only 75 per cent of which is subject to income tax and at a lower rate.

All monies retained in the pension grow free of income and capital gains tax, he notes.

While there will be a fund managers fee for retaining the monies in the pension, Mr Müdd says greater initial fees and potentially ongoing fees will arise in relation to buy-to-let property.

All monies in the pension are free from UK inheritance tax, Mr Müdd adds, whereas the full value of the buy-to-let property will be in the investors estate, and be chargeable to UK inheritance tax.

From a solely tax perspective, Mr Müdd says pensions are more efficient in every respect.

Bob Young, chief executive at Fleet Mortgages, says individuals need to think how the tax treatment of buy-to-let might translate into their annual income level and the impact this asset could have on their access to benefits.

He says it certainly would make sense for individuals to get full advice in this area from a later life adviser on their whole range of retirement income needs prior to making a decision to invest in property.

Mr Young says: “There are many things to consider and they could land themselves in serious trouble if they don’t consider the full picture.

“This is not simply a case of wanting to buy a property and accessing their pension to do so.”