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2015 pension changes explained

As of April 2015 over 55s can reinvest their pension pots. With some planning to invest in buy to let property what should they be aware of?

Changes implemented in 2015 meant that anyone aged over 55 can withdraw money from their pension and invest it elsewhere.

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Previously when you retired your pension pot was used to buy an annuity and you didn’t have many flexible investment options (besides drawdown schemes), there are now many options available that should be carefully considered.

The government offers pensioners some guidance through their Pension Wise scheme which is a sensible place to start your pension planning. Seeking individual financial advice tailored to your circumstances is also a good idea.

The new pension rules

If you are over 55 you have a variety of options for your pension pot:

  • Leave your pension pot untouched until you need the money
  • Get a guaranteed income: take 25% of your pot tax free before buying an annuity
  • Get a flexible income: either take 25% of your whole pot tax free, or take smaller cash sums each 25% tax free
  • Take your whole pension pot as cash: 25% will be tax free

How much tax you will pay

Only the first 25% of the money withdrawn will be tax free. The other 75% will be taxed at a marginal rate.

If you take 25% of your whole pension pot tax free, you can’t leave the remaining 75% untouched. You must either take it as cash, buy an annuity, or put it into a drawdown fund. Any returns you receive from the remaining 75% are taxable.

For example, if you have a £100,000 pot and you can take £25,000 tax-free in one go you would have to buy an annuity with the remaining £75,000 or put it in a drawdown fund.

If your annuity pays you £4,000 a year you would pay the marginal rate of income tax (20%, 40% or 45% depending on your other income) on it.

If you take the remaining £75,000 as cash you will pay at least 40% tax as it counts towards your annual income.

If you want to take smaller cash sums from your pension pot 25% of each sum would be tax-free. If you withdraw £1,000 every month, £250 of this amount would be tax-free, the other £750 is taxed at the applicable rate for your income.

More information can be found at Pension Wise, a free and impartial government service to help you understand pension options.

Using your pension for buy to let

Using your pension to invest in a buy to let property is not without risks, so here are some things to think about if you’re thinking about using your pension to invest in property and become a landlord:

  • You can take all or some of your pension pot as a cash lump sum (but remember the tax)
  • Property prices have been rising in recent years, but this is no guarantee of further rises
  • The private rental market has shown consistent growth, but rents have significant geographic variation
  • Mortgage rates are currently at historic low but buy to let mortgages are different to standard mortgages (typically more expensive and interest-only repayment)
  • Tax, agency fees, property vacancy and maintenance could all impact on your income

Investing in property

There are many investment options with varying degrees of risks and returns, but when the rules came into effect in April 2015, 16% of over 55s planned to use their pension pot to invest in property, according to opinion polls.

At the time of the changes, interest rates were at all time lows, making savings and ISAs seem less lucrative.

The private rental market has also shown consistent growth since the introduction of buy-to-let mortgages in 1996, with demand regularly outstripping supply.

But property investment is not without its risks. In essence, property prices have in general been rising fast in recent years, but this carries a risk, as what goes up can go down and if you buy at the market peak you may be caught out.

What’s more, the rental market has a lot of geographic variation and if you are thinking of renting out your property you should do comprehensive research on the rents in the area you’re planning to buy in.

It is often worth seeking independent financial advice before using your pension for any sizable invesment.

Buy to let: what you need to know

If you are thinking of buying a property to rent out and you do not have the money to buy outright, it’s likely you will need to look at a buy to let mortgage. This is different from a standard mortgage in the following ways:

  • Lenders take both your personal income and potential rental income into account when considering your eligibility.
  • The mortgage tends to be on an interest-only basis (but capital repayment is available), meaning repayments will not go towards repaying the loan. The sale of the property is typically used to repay the mortgage.
  • A buy to let mortgage is a commercial rather than a personal financial arrangement, meaning it is considered higher risk, so often you will need a larger deposit for a buy-to-let mortgage and rates tend to be a bit higher than standard mortgages.

It’s also worth understanding what will eat into your income as a landlord:

  • You will pay income tax at the marginal rate on your rental income and any profits from selling the property will be subject to capital gains tax
  • If you use an agency to let your property they may take a cut of around 15-20% of the rent
  • Your property may be vacant for periods of time with no rental income while you still have mortgage payments to meet
  • You are responsible for maintaining the property to a minimum standard

You should also understand your responsibilities as a landlord and make sure you are meeting all your legal obligations.

For more information read our top tips on buy to let mortgages.

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Buy to let mortgages

Looking for a buy to let mortgage? Our comparison tables show you a range of different fixed, variable or tracker buy to let mortgages.

Buy to let mortgages