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The announcement that the income from a joint lives annuity will be tax-free for the survivor of a marriage or civil partnership has to some extent leveled the playing field between the retirement options of buying an annuity and drawing down income and capital from a pension pot.
However, the flexibility and tax-efficiency now available through drawdown have made this the preferred option for many people, and the press has been quick to predict the demise of annuities.
But the situation is not black and white, and much depends on the age of the retiree. Annuities have the great advantage of providing a guaranteed lifetime income, so there is no risk of running out of money.
However, annuity rates are very low, and the younger the person is who is taking out the annuity, the poorer value the investment will provide. In particular, the rates available to 65 year-olds are a major disincentive.
So income drawdown is likely to be the immediate choice for younger retirees, though caution is required because if the drawings deplete the capital – perhaps exacerbated by a stock market setback – there can be no sure way of making up the shortfall.
The longer one can leave the purchase of an annuity, the better the rates will be; and current low interest rates (which dictate annuity rates) may not be with us forever. So a prudent approach might be to consider moving to the safety of an annuity at or after the age of 75,
A further factor is that as age increases, so also does the possibility that health will deteriorate and that enhanced annuity rates will become available which take account of a potentially reduced life expectancy.
For most people, annuities will continue to have an important role in financial planning for retirement.
Buy-to-let has been one of the most successful investment opportunities over the past decade, and now that there is to be complete flexibility as to how pension funds should be invested or spent, it is being suggested that a potential net rental yield of perhaps 5% makes buy-to-let an option well worth considering.
Since withdrawals in excess of the 25% tax-free cash available from a pension pot will be subject to tax at the investor’s highest marginal rate, most investments would be funded by the tax-free cash. In many cases this would be more than sufficient for a property purchase. But there are snags.
First, there are costs involved. Putting aside the hassle of dealing with tenants and repairs, stamp duty will be payable on the purchase and capital gains tax on a sale.
Secondly, having a buy-to-let property in addition to one’s home could represent a risky commitment to a single asset class, namely the unpredictable property market.
Third, property investment is illiquid, and it could prove difficult to sell the investment in the event of an unexpected need for cash.
Fourth, if the purchase involves any borrowing, it would be unwise to base financial calculations on current interest rates. At some point in the future they are bound to rise.
Finally, there is the political risk. The housing shortage benefits landlords but penalises tenants, mostly young people, and this situation is being supported by the Government, which pays out housing benefit of around £9.5 billion every year and relieves landlords of some £5.6 billion in tax. This situation might not be permitted to continue.
The housing shortage might be addressed by an acceleration in the building of new homes, which would cause rents to fall. Equally, the demand for rental accommodation would fall if the UK were to leave the European Union and East European renters were to leave the UK.
Buy-to-let can be a good investment, but it may not be the best place to put pension savings.
The changes to stamp duty on residential properties announced by the Chancellor in his Autumn Statement will reduce the cost of this tax for the great majority of people but will have severely negative consequences for the value of more expensive properties.
Until 4 December 2014, when the changes came into force, a so-called ‘slab’ system operated, whereby increased rates of tax were applied to the whole value of the property transferred when a trigger value was exceeded. Under this system, a difference of £1 in value could result in an extra tax charge of £5,000.
The new system is progressive, so only the excess over a given tax threshold would bear the higher rate of tax. However, the rates of tax charged have been increased, and houses worth more than £1.5 million will bear a charge of 12% on any amount over that threshold.
Consequently, a property sold for £5 million would bear tax of £513,750, compared with £350,000 previously.
The Scottish Parliament is introducing a similar system with effect from 1 April, but the rates and the thresholds will be different, and the 12% rate will apply to properties valued at over £1 million.
The prospect of a future Labour government introducing a mansion tax would further undermine the investment value of the more expensive residential property, and whereas the figure of £2 million has been mooted for mansion tax, the fact that the top rate of stamp duty bites at £1.5 million might tempt egalitarian politicians to start mansion tax at the same level.
DISCLAIMER: Please note – The information contained within this communication does not constitute financial advice and is provided for general information purposes only. Simmons Gainsford Financial Services shall not be held liable for any technical, editorial, typographical or other errors or omissions within the content of this communication. The advising on and arranging of occupational pension schemes is not regulated by the FCA. Arranging group personal pensions and group stakeholder schemes may be deemed to be a regulated activity. No responsibility can be accepted for the accuracy of the information in this newsletter and no action should be taken in reliance on it without advice. Please remember that past performance is not necessarily a guide to future returns. The value of units and the income from them may fall, as well as rise. Investors may not get back the amount originally invested.