In his March 2014 Budget, Chancellor George Osborne outlined a huge shake-up of UK pension legislation. On the initial face of it, there were not many of his provisions that would impact hugely upon the property market. However, there is the potential that the pension changes could have an impact on the Buy to Let sector and therefore the wider market. Why? Read on!
The pension reform in the Chancellor’s Budget 2014 scrapped the requirement for retirees to purchase an annuity with their pension fund, as of April 2015. Other regulations affecting pensions will also be relaxed as of 27 March 2014.
What is a Defined Contribution Pension and an Annuity?
Up until the changes were announced, the vast majority of retirees who had a defined contribution pension would purchase an annuity. A defined contribution pension scheme is one where you and/or your employer contribute a set amount towards your pension fund each month At retirement the fund value would depend on the amount you had paid in as well as the investment performance over the years.
Upon retirement the pension holder would normally take 25% of the built-up fund as a tax-free lump sum, with the remainder being used to purchase an annuity. This annuity would provide the retiree with an income for life. The income payable would depend on a number of factors, such as the age at retirement, the retiree’s health and/or smoker status, and the company from whom the annuity would be purchased.
What Do These Changes Mean for the Requirement to Purchase an Annuity?
The first change is that, as an interim measure, pensioners over 60 can now withdraw the full amount of their pension fund if their overall provision does not exceed £30,000, up from the current £18,000 level.
As of April next year, however, the changes are much more drastic. Anyone aged 55 or over can withdraw their entire pension fund to spend or invest as they please. The first 25% of this will continue to be be tax free, as it is at the moment. The next £10,000 will be classed as the retiree’s tax free allowance (subject to any other income of course). The remaining fund can be taken as a lump sum, taxable at 20% (subject to the individual’s tax status at that time).
For many people, having the freedom to choose what to do with their finances is a huge positive step forward.
What Effect Might This Have on the Property Market?
Rather than purchase an annuity, which in recent years have been deemed to provide poor value with limited flexibility, retirees will have the option to take the lump sum and invest (or indeed spend) it as the please. One of the options open to people will therefore be to purchase a property (or properties), in the hope that this will provide an attractive rental yield as well as the possibility of capital appreciation over the longer term.
Buy To Let property of course offers varying yields, and the yield is only as good as a tenant’s willingness to pay rent. However, yields can range typically from 3% to 10%. Compared to interest rates on savings accounts at the moment, Buy to Let can look very attractive.
The rental market has seen a boom since the property market crash in 2008. Due to restrictions on residential lending, increased numbers of people had to move into rented accommodation as opposed to buying. As a result, rents have increased significantly in the last few years whilst properties have become more affordable to buy. However, with lenders having relaxed their lending criteria in recent times and with greater availability of mortgages, it could be easier for retirees to invest in property, even if they require a mortgage to do so.
Is There Danger of a Pension-Fuelled Property Bubble?
Some critics of the Chancellor’s pension reforms suggest that property prices will rise as a result of pensioners rushing towards the Buy to Let market. Is this likely? It’s worth remembering that, whilst we have seen a significant rise in prices in Edinburgh and the Lothians recently, the price of most property has not returned to the levels of the early 2008 peak.
There is of course absolutely no guarantee that people will choose to invest in this manner as many other alternatives exist. However, the longer that interest rates stay low the more chance there is that people will choose to invest in riskier, higher yield options such property with a view to generating income through rent.
The best advice for anyone looking to take advantage of the new-found freedom afforded them by this new pension regime is to take advice from a professional adviser.