Buy-to-let is a whole subject in its own right, but it’s worth a quick mention here as it has become a popular way to invest to generate retirement income.
When discussing buy-to-let, many people view the subject as ‘buy-to-let versus pension’. This is probably because it isn’t possible to hold individual residential properties as an asset within a pension.
A more useful way to look at the subject is to separate the tax treatment or ‘wrapper’ from the asset. Generally speaking, assets held outside of an ISA or pension – whether they are shares, commercial property or residential property – are less tax-efficient than assets held within these wrappers.
For example, shares held outside of a pension are subject to income tax on any dividends they pay (if you are a higher rate taxpayer) and capital gains tax on any growth in capital value. The value of a directly-owned share portfolio also forms part of your estate for inheritance tax purposes.
Compare this to shares held within a pension where the purchase price of a share portfolio is subsidised with tax relief, dividends don’t attract any further tax and capital gains are also tax-free. Money held in a pension is also exempt from inheritance tax. Tax is paid when assets are cashed in and withdrawn from a pension, but usually 25% of the amount cashed in and withdrawn is tax-free.
As mentioned, residential property as an investment can only be held directly, meaning it is always subject to less favourable tax treatment, compared to own home or ‘principal private residence’.
Looking at residential property as an asset or investment, it has generally performed well over the long-term, both in terms of the income and capital growth produced. However, similar long-term returns have been achieved by investments in shares and commercial property, both of which can be held as assets within more tax-efficient wrappers such as ISAs and pensions.
Buy-to-let investors should also be aware that the tax treatment of buy-to-lets is set to worsen. From tax-year 2017/18 onwards, the rate of tax relief on mortgage interest payments will gradually be reduced to 20%. See our Summer Budget Report to find out more about this.
So, in summary, buy-to-let is historically an asset that potentially provides good returns; but it isn’t taxed favourably.
And, of course, the past is no guide to the future, regardless of whether we are talking about shares, commercial property or residential property. The value of any investment may fall as well as rise and you may get back less than has been invested.