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Building a retirement fund? Why I’d avoid buy-to-let

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The British have a singular attachment to property that is best summed up by the expression ‘an Englishman’s home is his castle’. And in recent decades, our passion for bricks and mortar extended beyond our own homes and buy-to-lets (BTL) became an incredibly popular second income stream for many people.

This was possible as you could easily buy a home with a mortgage. The profits would cover the interest on your mortgage and provide an income, or you could put the money toward paying off the mortgage to increase your assets. This was once a fantastic option for those who were willing and able to participate. However too many rental properties coupled with a lack of new supply has made it very difficult for new buyers to find a home, which has made BTL landlords a target for the government.

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A dangerous move?

The government has introduced a new system to change the way tax is calculated on rental income. The result does not have much of an impact on the basic rate taxpayer, who will essentially still pay 20% tax on profits after expenses and mortgage interest is deducted. However, higher rate taxpayers (those who earn over £46,350) will effectively pay 20% tax on all rental income, whereas previously, interest payments were fully tax-deductible.

The effect of this is that it will make owning properties with low profit margins very difficult for higher rate taxpayers. This could diminish the size of returns or even lead to rental income becoming insufficient to pay off interest that is due on the mortgage. These changes will not come into full effect until 2020 but if I was a higher rate taxpayer, I would not be considering buy-to-let at this time. Even if you can make a profit after interest, any serious maintenance expenditures could still eat into both that profit and your savings.

Safe as houses

In addition to income, another reason to invest in BTL has been the presumption that the value of the property would increase over time. It is true that UK house prices have outperformed the FTSE 100 over the last 20 years. But the ‘cons’ are starting to outweigh that big ‘pro’. New buyers will now face a huge increase in fees that will eat into any profits; home buyers now pay 3% stamp duty with an additional 5% stamp duty for homes in the £250,000 to £925,000 bracket; and you will also pay at least 18% tax on any capital gains you make from the sale of a second home.

Build savings for retirement

One of the main benefits of investing in property is that you can buy it with other people’s money (a mortgage) and this advantage remains. However with the increases in tax and stamp duty in addition to capital gains, I think investors with cash now have much better options than putting down a deposit on a second home. Taking out a tax-free stocks and shares ISA can provide investors with a wide range of options that do not require significant risk or high levels of knowledge of the stock market. My recommendation for a new investor would be a diversified tracker fund paid into with small regular payments to smooth out market fluctuations.

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