The 33% Tax Risk in Using Pensions for Buy-to-Let (BTL) Property

There’s a new warning for people thinking of using their pensions to buy Buy-to-Let properties.

  1. Pensions and Buy-to-Let Properties: Some people are thinking of taking money out of their pension pots to buy a second home, especially to rent it out and get some income. This sounds like a good idea at first, because, hey, who wouldn’t want another source of income, especially when they retire?
  2. Research Findings: A study done recently showed that 15% of folks aged over 55 are thinking of doing this. But, the younger crowd, those aged 45-54, are even more eager, with 29% considering it.

The Warning:

Royal London, a big financial company, says, “Hang on a minute!” If you do this, you might end up with a hefty tax bill. Here’s why:

  1. Income Tax on Pension: When you take money out of your pension, especially a big chunk at once, you have to pay income tax on it. Think of it like this: you’ve been putting money into a piggy bank all your life, and now when you smash it open, a portion of those coins are going to Mr. Taxman.
  2. Stamp Duty: On top of that, if you’re buying a second home, you also need to pay something called ‘stamp duty’, which is an additional tax. This is a bit like paying an entry fee to a club; only this club is the “I own more than one house” club.
  3. Example: Let’s say you have £400,000 in your pension. If you take it all out at once to buy a house:
    • You’d first pay £120,000 in income tax.
    • Then, you’d need to cough up an extra £12,400 for the stamp duty (because it’s your second property).
    • So, from the original £400,000, you’d be left with £267,600. That’s just two-thirds of your money!

A Deeper Look at the Numbers:

Depending on how much you have in your pension, here’s a breakdown of the taxes you’d be paying in England and Northern Ireland:

  • £200,000 Pension:
    • Income Tax: £52,500
    • Stamp Duty: £4,875
    • Remaining: £142,625
  • £400,000 Pension (the example above):
    • Income Tax: £120,000
    • Stamp Duty: £12,400
    • Remaining: £267,600

(And so on for larger amounts…)

If you’re in Scotland, the situation’s even a bit more challenging due to different tax rules.

Other Details:

  • These numbers come from a situation where someone takes 25% of their pension tax-free and has no other income that year.
  • The second home’s tax is calculated after the pension income tax has been sorted.

Advice (or Lack Thereof):

Even though experts can advise about these costs, 25% of those considering this move won’t seek financial advice. But, Royal London advises speaking to a professional. They warn that if you don’t understand how these taxes work, you could get a nasty surprise and lose a lot of money.

In a nutshell: If you’re thinking about using your pension to buy property, understand the taxes first or chat with someone who does!