Empty your pension and invest in buy-to-let? No, do it the other way round
04-13-2015
Using the pension freedoms to invest in buy-to-let will mean a big tax bill. But selling rental property to put money in a pension will save you tax, says Richard Evans
Many buy-to-let investors face a big capital gains tax bill when they sell. Putting the proceeds in a pension could more than wipe out this cost Photo: Alamy
By Richard Evans
It's the sentence I thought I would never write: pensions have become interesting. The new freedoms, which take effect tomorrow, have got people up and down the country thinking about how they can use unrestricted access to their pension money to make their lives better.
A shake-up as fundamental as this one is bound to create dozens of clever, unexpected opportunities for savers to benefit. Pension experts have come up with a few already, but more will emerge once the new regime is actually up and running.
Here are a few of the possibilities I can envisage.
There has been a lot of talk about savers who prefer bricks and mortar to financial assets seizing the opportunity to withdraw all their pension money and using it to invest in a buy-to-let property. But, as Telegraph Money has reported previously, the taxes you would have to pay could be crippling.
First there's the tax on the pension withdrawal, some of which will be at 40pc, especially if you are putting down a large deposit or buying outright.
Then there is the capital gains tax due on any appreciation when you come to sell. Finally, by taking assets out of a pension you expose them to inheritance tax.
But how about making the opposite transaction? Many buy-to-let investors face a huge capital gains tax bill when they come to sell, thanks to the property boom that many parts of the country have experienced in recent years. A pension offers a way to nullify this liability, while also shielding the assets from inheritance tax.
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This is how it would work. If you sell your buy-to-let and put the proceeds in a pension, you get tax relief on the contributions. Assuming that you pay the higher rate of income tax, the sale will trigger a capital gains tax bill at 28pc, the higher rate. But you get all this back and more when you put the money in a pension – in fact you benefit from 40pc tax relief.
Admittedly, you will probably run up against the annual limit on pension contributions, which is £40,000. But there are even ways around this. First, you can, subject to some conditions, carry forward three years' worth of unused contributions. Second, you can drip-feed in the money in future years, as long as you have sufficient earnings elsewhere on which you have paid tax (this is an argument for carrying out the transaction while you are still working).
Once the money is in your pension it is outside your estate for inheritance tax purposes and, under the other aspect of the pensions revolution, the abolition of 55pc "death tax", can be passed on to your family with either zero tax to pay or just the beneficiaries' own marginal rate (see our story Use your pension to cut your inheritance tax bill to zero).
The assets you choose to buy with the money once it is inside a pension can thereafter grow, and produce income, tax free. Withdrawals are taxable, but you can control them in such a way as to be tax-efficient, perhaps by drip-feeding out the 25pc tax-free lump sum every year and topping this up with other withdrawals up to the basic-rate limit.
So instead of facing three tax bills if you withdraw pension money to fund a buy-to-let, you get an uplift from the taxman from the sale and transfer, then get tax-free growth and no death taxes.
The final problem is choosing the assets to buy within the pension to replace your buy-to-let property. Residential property cannot be held in a pension, but commercial property can. So you could look around for, say, a dentist's surgery or solicitor's office to buy and rent back to them. Alternatively, there are property funds that produce a decent yield and offer the chance of capital appreciation.
If you are comfortable leaving bricks and mortar behind, you could look at retail bonds, individual shares or funds that invest in bonds, shares or a mixture.
Not everyone has a buy-to-let property, of course. But some of the same arguments apply to your Isas. By selling your Isa asset and reinvesting the proceeds in a pension a higher-rate taxpayer will benefit from a huge uplift thanks to 40pc tax relief. You can then buy back, within your pension, the same investments. These assets are now shielded from income tax, capital gains tax and inheritance tax.
Selling your buy-to-let and Isas in favour of pensions? This really is a revolution.