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We come to the rescue of Suzanne who is weighing up what are the best options to give her a comfortable retirement
Suzanne Bearne is a freelance journalist and media consultant and has strong finances – at least on the surface…
Find out more: “My stocks and shares ISA will help me retire early”
Money SOS: Suzanne Bearne
Suzanne left London four years ago to get on the property ladder, overpays her mortgage, has robust emergency savings of £25,000, and has amassed £10,000 in a stocks and shares ISA.
However, Suzanne doesn’t have a pension and is wondering if buying a rental property would be a better way of funding her retirement.
“I was thrilled when I bought my two-bedroom flat in Margate. It’s something I thought was impossible as a freelancer buying on my own.”
Although the pandemic and lockdown impacted her work, the 38-year-old received a grant from the government’s Self-Employment Income Support Scheme and made changes to her work life.
“My income took a hit due to the pandemic but I’ve pivoted to make sure I have multiple income streams. I turned planned workshops into webinars, created an online course.
Find out more: How to start a business
Investing in her future
“I don’t want to be screwed when I retire,” she says.
“I have no intention of becoming a property magnate, though. If I did buy another property, it would just be the one – and one that I would view as my future pension pot.”
She has a target purchase price of £200,000 and needs to know what she might be setting herself up for financially.
“I don’t want to spend all of my £35,000 savings and am keen to use the equity in my property, which I bought for £155,000 in 2016 and is now worth £250,000.
“What kind of a deposit would I need? What taxes would I pay? What impact would a buy-to-let have on my finances?”
Find out more: Should I invest in property to fund my pension?
Investing ethically
She would also like to know more about investing ethically in her stocks and shares ISA – and in a pension if she opts for that over a buying a rental property.
“I want to be in control of any investments and choose ones that sit comfortably with me.”
Find out more: Guide to ethical investing
Suzanne’s aims
Find out more: Eight simple ways to boost your pension pot
Investing in a buy-to-let
UK house prices have skyrocketed in the past 20 years, which is the reason that, despite blips in the market, so many people view property as such a good investment.
This is certainly what Suzanne is thinking after seeing her home increase in value from £155,000 to £250,000.
Her mortgage overpayments allowed her to reduce the outstanding balance to £111,000.
“I am thinking Margate is a good investment area and there seems to be a trend to move out of London and busier places.”
Find out more: How to turn your own home into a successful investment
Changes to buy-to-let investing
There have been some changes that make investing in buy-to-let property less attractive than it once was. These include:
- Mortgage interest tax relief cut to zero, with landlords instead given a 20% tax credit on their mortgage interest
- Buy-to-let investors have had to pay an extra 3% in stamp duty since 2016
- Mortgage-lending criteria are tightening
- Buy-to-let properties now need a minimum EPC (energy-efficiency) rating of E (A and G are the most and least efficient, respectively)
Another aspect to consider if you are new to buy-to-let is the concern over tenants being unable to pay their rents and whether you are happy to manage a property.
Find out more: Is it still a good time to invest in property?
The benefits of property investment
However, property investment can be profitable in the right circumstances.
David Hollingworth from the mortgage broker London & Country Mortgages gets down to the numbers and logistics.
“One of the first things to think about, aside from the financing and budget, is the likely demand from tenants – so understanding the local market where she plans to buy will be really important,” he says.
“That will help to target the right type of property to appeal to tenants and minimise the potential for breaks in rental income, which is so important to any buy-to-let investment.”
Suzanne will need a bigger deposit than would be required for a main home.
“Although some lenders can offer mortgages to those with slightly smaller deposits, the typical requirement will be at least a 25% deposit, equating to £50,000 on Suzanne’s target price of £200,000,” says Hollingworth.
Find out more: Guide to buy-to-let remortgages
Hidden fees
There will be the usual costs that she paid first time round:
- Mortgage and valuation fees
- Broker fees
- A survey
- Solicitors’ fees
- Land Registry fee
- Buildings insurance.
A rough estimate of all these hidden costs is £6,000.
The stamp duty surcharge
Another cost to consider is stamp duty and the fact there will be a surcharge of 3% payable, on top of the normal stamp duty rates, for the purchase of an additional property.
Suzanne would pay stamp duty of £7,500 (2% + 3% surcharge) on a property costing £200,000.
Find out more: How to avoid stamp duty
Paying for a second property
Based on all these figures, Suzanne would need £62,000 to buy a second property.
She is prepared to use £15,000 of her personal savings and keen to unlock some of the equity in her home to raise the remaining £47,000.
How would this work in practice?
“In order to release equity from her main residence, Suzanne will need to demonstrate that her income is adequate to meet the lender’s affordability criteria,” says Hollingworth.
“If she is tied into her current mortgage deal with early-repayment charges, then she may want to consider the option of a further advance from the existing lender to avoid a penalty.
Remortgaging her home
“If she is not locked in, however, she could shop around the market for a remortgage deal on the whole of the new borrowing. This is the £111,000 still left to pay on her mortgage plus the £47,000 she needs to put towards the purchase of the second property,” says Hollingworth.
The rest of the purchase price would be funded by a mortgage.
Find out more: Is remortgaging a good idea?
Put through your paces
Hollingworth describes how lenders put buy-to-let applicants through their paces.
“The level of buy-to-let mortgage available will largely depend on the amount of rental income that the property will generate,” he says.
“Lenders will want to see that the rent will be adequate to cover the mortgage interest by a set amount and calculated using a ‘stress rate’.
That is designed to give some cover for any other costs or future interest rate rises.”
Hollingworth gives a realistic scenario: “It could require the rent to be 145% of the interest calculated at a stress rate of 5.5%, which on a £150,000 mortgage would mean a rent requirement of a little under £1,000 per month – although some lenders could be more flexible.”
Find out more: Should I use a mortgage adviser?
Using an agent
Suzanne should also decide whether she wants to use an agent to manage the property – standard rent management costs around 11% of rental income – and also think about how she’d pay the mortgage if there were a period where she was unable to find tenants, and the costs of maintaining the property.
On top of all this, rental income is of course taxable.
Suzanne earns a bit under £50,000 a year and is looking at an extra £12,000 in rental income if she goes down the buy-to-let route.
Find out more: How to fill in a tax return
Tax and rental income
Tax expert Michael Martin at Seven Investment Management points out that this income would make her a higher-rate taxpayer.
“She would be taxed at 40% on any income above £50,000. Additionally, any increase in the price of the property, were you to sell, would be subject to 28% capital gains tax above your CGT allowance [£12,300 in 2020-21].”
Pros of investing in property
- You own something tangible
- Property values are on a long-term ascent, so there is a good chance of benefiting from capital growth
- You benefit from rental income as well
Cons of investing in property
- Costs can be high – the big deposit, stamp duty, repair costs, legal fees, surveyors’ fees, and agents’ fees if you outsource the management of the property
- You will pay income tax on your rental income and potentially capital gains tax if you sell up
- You pay more in stamp duty as a buy-to-let landlord
- You can lose money because of problem tenants or periods when the property is empty
- Managing a property can cost you time if you manage the property yourself
- You may not be able to sell it when you want or get the price that you want
Find out more: “I make thousands in profits investing in property without actually buying it’”
What about a pension?
Suzanne has spent significant stints abroad – including travelling in Australia and South America, plus periods living in New York, Berlin and Lisbon – so it’s first worth checking the status of her workplace pension.
Everyone can check on gov.uk to see whether they are on track to receive a full state pension – or if they have any shortfalls in national insurance contributions (NICs), which will bring down the entitlement but can be topped up.
You can also see at what age you are likely to receive the pension.
She logs on. “It tells me I have four years when I did not contribute enough, but also 18 years of fully paid-up NICs and I can claim [the maximum] £175.20 a week from April 2049 – when I will be 67.”
You need 35 qualifying years to get the full new state pension, so Suzanne – with so many working years ahead of her – is on track to receive hers.
Find out more: State pension: how much will I get?
How much do I need for a comfortable retirement?
The insurer Royal London claims you will need to build up a pension pot of £260,000.
This will provide an annual income of just over £13,000 a year if you use that pension fund to buy an annuity – an income for the rest of your life, regardless of how long you live – at today’s rates.
When added to the state pension of about £9,000 a year, this gives about £22,000 a year as a regular income.
Find out more: Money SOS: “I’m almost 40 – is it too late to build a decent pension?”
Drawdown or annuity?
Most people choose to take cash from their pension flexibly via drawdown in retirement, rather than buying an annuity.
So a pension pot of £260,000 would mean Suzanne should be able to take £13,000 each year for 20 years, using drawdown.
In practice, she could probably take more, as the pension pot will still be invested; if it rose in value, she would benefit from the growth.
Taking cash flexibly means she would be able to take less in some years and more in others.
Find out more: Should I go for an annuity or drawdown?
How much does Suzanne need to save?
As a 38-year-old with no pension savings, Suzanne would need to start saving £363 a month (which also includes tax relief, and any contribution from an employer if she has access to a workplace pension in future).
This is in order to achieve a pension fund of £260,000 by the time she reaches pension age.
This assumes an annual management charge of 0.5% and investment growth of 5% a year.
Read our Pensions guide for more information on how to build your pension.
Freelance life
Suzanne also wants to factor in her voluntary work and the precariousness of freelance life.
“I need to make sure I have enough money if freelancing becomes more difficult and my income drops.
“Volunteering is also very much part of my life – for the National Youth Advocacy Service, Crisis and a local shelter – and this is something I want to increase when I’m older.”
Let’s imagine Suzanne ends up working part-time from the age of 60 – either because she is forced to or she starts winding down to do more voluntary work – and wants the same £260,000 in her pension fund.
She would need to put away £390 per month from now until she is 59 – and then £195 per month until retirement.
Find out more: How to become a freelancer
Her options
Suzanne could opt for a self-invested personal pension (SIPP), which, as the name suggests, allows you to choose the investments that go inside the pension.
SIPPs are similar to a standard personal pension but offer more flexibility and a wider investment range.
The “self-invested” part means it is you, rather than the fund manager, who selects and monitors the investments.
Or she could choose a ready-made personal pension which is an investment portfolio created and managed for you by the pension provider, often based on criteria such as how much risk you want to take.
Find out more: Best SIPP providers 2021
Pros of the pension option:
- Contributions are flexible
- You get free money from the government in the form of tax relief on your contributions. As a basic-rate taxpayer, if Suzanne were to contribute £100 a month from her salary into a pension, it would actually only cost her £80. The government adds an extra £20 on top – what it would have taken in tax from £100 of her salary.
- Money is invested in a mix of assets, which spreads your risk
- You can, in theory, set up and forget about your pension (though it’s a good idea to review it regularly), while managing a property is more hands-on
- Your pension is protected if the provider goes bust (SIPPs are protected up to £85,000).
- You can take money out of your pension fairly easily when you retire
Cons of the pension option
- You can’t get your hands on the cash until you are at least 57 (the minimum age is currently 55, but it will rise to 57 in 2028). However, this may be less of an issue if you have an ISA and substantial savings that you can use before this time.
- There is no guarantee of how your investments will perform – you may pick assets that fall in value
- You pay income tax on any money you take out of your pension pot above the 25% tax-free lump sum
Should Suzanne choose a buy-to-let or a pension?
Suzanne could buy a buy-to-let – but with her eyes open to the fact that:
- It is expensive
- It can be time-consuming
- The government has been squeezing landlords in recent times and it could be a potentially scary time to buy if prices crash next year.
However, regardless of whether she buys a rental property, she should definitely open a pension.
There are no upfront costs and the tax relief alone makes it a no-brainer. Free cash from the government? Yes please.
Our mentors are on standby to come to the rescue of any Money SOS you may have. Get in touch if you need some help: questions@timesmoneymentor.co.uk
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