Property or investing? How to save huge amounts in tax…

10 April 2024

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When it comes to building wealth, individuals often find themselves at a crossroad in the quest for financial diversification, stability, and growth. The two main areas that are at the forefront of this age-old debate is whether to invest in property or in an investment portfolio.

Both avenues offer promising and enticing opportunities for wealth accumulation. Understanding the dynamics of both is paramount. This article aims to dissect the costs involved and how to better maximise the tax position.

The ongoing debate

Historically, property has been considered a stable investment that has been a preference of investors due to it being a tangible asset, as opposed to an investment portfolio which has been regarded as more complex and carrying a greater risk.

It seems, however, in recent years there has been a change in mindset following many people underestimating the work and expenses associated with property investment, as well as the constant changes to its tax status.

Whilst both avenues can provide long-term capital appreciation prospects, utilising an investment portfolio has historically delivered higher average returns.

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For example, in the last 20 years the MSCI world index has provided over 4 times the return of the UK property index [1]. An investment portfolio also comes with the added benefit of providing greater liquidity and tax planning scope which are key factors when considering the best route to provide an ongoing income.

Whilst we could explore numerous attributes of each position, I have delved into the workings of the two investment strategies when utilising them for income purposes below.

Example scenario:

Joe – He is weighing up the prospect of investing £500,000 in an additional property, he only owns his main residence separately.

Diana – She is a client who alternatively wants to invest £500,000 of capital and work closely with a financial planner to structure the investments in various tax vehicles. I have kept the products simple.

We have assumed Joe and Diana are both higher rate taxpayers and they receive an existing income of £80,000 each.

Initial costs

The initial charges associated with an additional property purchase are often overlooked when comparing against investments. I have not gone into specific detail on the individual costs associated with a property but highlighted the two most expensive outlays, generally.

Joe

As this will be a further property, the additional stamp duty rates will apply.

Stamp dutySolicitor fees Total
£27,500 (5.5%)*£2,500£30,000

*Stamp duty land tax calculator [2]

Diana

This will very much be driven by the complexities of the advice, and it will vary, but we would expect the initial advice fee to vary between 1-2%.

Initial advice fee
£5,000-£10,000

As highlighted above, there is a significant difference in the initial fees and tax due of £20,000 on a worst-case basis, this represents 4.00% of the planned initial investment. As stated, there are a host of other costs to factor in with the property, including maintenance.

 

Ongoing costs & tax

We have then compared and analysed the ongoing costs and tax implications of both scenarios.

Joe

Joe is expecting to earn a respectable yield of 6% from this property, which will provide him with £30,000 gross pa. I have ignored potential increases in the initial values of the property and investments for the purpose of showing the different tax treatment when relying on each investment type for an ongoing income.

Annual rental Management feesYield pa net of management feesTax @ 40%Net yield
£30,00015% (£4,500)*5.10% (£25,500)£10,2003.06% (£15,300)

*letting agent fees range from 10-20%, so we have used the median figure [3].

As highlighted above, once taking into account management fees and the tax, the yield is substantially reduced.

In addition to this, the rental income Joe will receive will push his income in excess of £100,000 which means he will start to lose his personal allowance. For every £2 of income over £100,000 the personal allowance of £12,570 is tapered by £1 [4]. This would mean Joe is effectively paying 60% tax on this element of income that no longer falls within his personal allowance.

Diana

For Diana, to keep matters simple we have assumed the £500,000 will be invested as follows:

Product/investmentInvestment amount
ISA£20,000
General Investment Account (GIA)£180,000
Bond£300,000

Each product above is treated differently for tax purposes. ISAs are exempt from income and capital gains tax but have an annual subscription of £20,000. GIAs are subject to capital gains tax on any gains crystallised above the CGT allowance of £3,000 (as of 6 April 2024) but no income tax is payable when withdrawing capital. There is however income tax payable on any income generated from the underlying holdings. A bond allows for income of up to 5% of the original amount invested to be withdrawn each policy year without creating a chargeable tax event, it is also cumulative.

One product that is not mentioned above is a pension and I will highlight this further on in the article, but this has been excluded in this scenario due to the age restriction that applies when accessing a pension. [5]

We have replicated the same £30,000 income that Joe is receiving through the rental property by withdrawing a specific income from each product that supports their structure.

ProductIncomeTaxNet income
ISA£2,000Nil- ISAs are tax free6% (£30,000)
GIA£13,000Nil- assuming gains fall within the CGT allowance
Bond£15,000Tax deferred 5%*

*This assumes that the bond withdrawals are return of capital and this is drawn every year over a period of 20 years until the client has received their full original investment back through withdrawals

You should notice that the investment position provides a greater income of £14,700 pa, with no income tax paid on the withdrawal. By paying no tax whatsoever or even just limiting the tax paid, this avoids putting too much pressure on a particular vehicle to provide the income required which in turn aids ongoing sustainability.

Do you want to improve your tax position?

The more tax you pay, the harder your investments must work to grow your wealth. Our advisers can provide practical advice to help reduce your tax bill. Get in touch to discuss how we can help you.

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What does this look like over a 10-year term?

Property tax & maintenanceTax over 10 yearsInvestment taxTax over 10 years
£14,700£147,000NilNil

Over ten years, Joe, the property investor, will pay £147,000 more in tax. It is a huge difference! The gap only widens as you increase the initial investment depending on how well structured the investments are, this is why it is so important to work with a financial planner over the long term to build a tailored strategy.

It is important to emphasise that this is fairly basic tax planning, and we would assess each position in great detail to determine the most effective strategy.

Disposals of a property vs investment portfolios

As with any investment, a vital consideration will be what the tax position will be on disposal, especially if profit is being crystallised.

Any gains that are made on additional properties are subject to capital gains tax (CGT). Each individual is currently entitled to a capital gains allowance of £3,000 in the present tax year, which is half the allowance of previous tax years.

Property is subject to higher rates of capital gains tax in excess of the CGT allowance in comparison to investments, such as a General Investment Account (GIA). ISAs, bonds and pensions are exempt from capital gains tax, so you can often save a huge amount of tax by structing capital in different products. I have summarised the position below:

PropertyTax rateInvestmentsTax rate
Basic rate threshold18%Basic rate threshold10%
Higher & additional rate threshold24% from 6th April 2024*Higher & additional rate threshold20%

*It was announced in the March budget that from 6 April 2024, the higher rate of capital gains tax (CGT) on residential property sales has been cut from 28% to 24% but it remains at a higher level than investment rates. [6]

In summary, investments tend to provide much wider choice and flexibility when it comes to crystallising gains due to the greater liquidity and diversification options. This is why it is so important that advice is taken when looking to manage and mitigate your CGT liability.

Further tax planning

Pensions

Although excluded in this example, pensions can play a significant role in an individual’s investment portfolio for many reasons. Pension contributions are an extremely powerful tool in contributing to wealth accumulation as they benefit from tax relief, they are also mostly exempt from inheritance tax.

Let’s assume Diana funded pension contributions separately and her existing £80,000 of income was classed as pensionable earnings. We could look to reduce Diana’s existing income position down to the basic rate threshold for tax purposes. We would do this by making a £30,000 gross personal contribution, which would cost Diana £24,000 upfront.

Initial outlayInitial tax reliefExtra tax relief*Effective cost
£24,000£6,000£5,946£18,054

*This is often claimed through self-assessment if made via the relief at source method.[7]

The table emphasises how the tax relief applied is substantial, especially if this is repeated each tax year. If we forecasted this over a 10-year period, it would result in an increase in wealth of circa. £119,460, all paid through tax relief.

Inheritance tax (IHT)

Most people that hold property as part of their retirement or investment strategy come to the point where they start to think about inheritance tax planning. Property makes it increasingly difficult to mitigate IHT as your options are limited to either selling or gifting it away. Due to its illiquid nature, it makes it very difficult to carve up and gift parts of a property gradually, so it is often all or nothing and any control is completely relinquished on gifting the asset. Furthermore, upon gifting a property, then you will be treated in most scenarios as making a disposal for capital gains tax purposes and this can trigger an extremely unpleasant tax bill.

Investments on the other hand allow for fluidity in terms of enabling several options that align with individuals’ goals and circumstances. This could be anything from retaining access, preserving an element of control, or just gradually passing wealth over to avoid one large capital gift that can be overwhelming. There are numerous options we have at hand and the following are the most common: general gifting, trust planning, pension planning, business relief and just spending it!

Conclusion

In conclusion, both property and investment portfolios offer unique opportunities and diversification across both asset classes can be a prudent strategy for building a resilient plan. However, I would recommend you do not discount utilising an alternative approach such as a well structured investment portfolio as this article highlights the huge potential tax savings that can be achieved through working with a financial planner on an ongoing basis.

Please note, you need to be aware of the risk associated of any investment as with both investment opportunities, you could get back less than you originally invest. You should always seek advice from a professional.

Do you want to improve your tax position?

The more tax you pay, the harder your investments must work to grow your wealth. Our advisers can provide practical advice to help reduce your tax bill. Get in touch to discuss how we can help you.

Request a call back

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Article sources

Editorial policy

All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.

Saltus Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.

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