The financial planning journal

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

20 July 2021

Everyone wants to save tax and make money out of property but, perhaps, the two are mutually exclusive.

Property can be appealing – it’s familiar, you can see it, you can even go and knock on the door, and people always need somewhere to live. Is property really a great investment though?

Well… when it comes to tax, I’m going to put my controversial stake in the ground and say “no”. Before you begin yelling at the screen, let me take you through some numbers:

Let’s compare two investors, who have built up their assets in different ways for retirement:

James: A pure property investor, holding only rental properties.

Olivia: Olivia is working with a financial planner. She uses investment portfolios and holds her investments in some fairly ‘vanilla’ tax vehicles that are available to everybody.

Both investors hold assets worth around £2.5 million and enjoy the same level of gross income.

James

We’ll start with James, our property investor, he’s earning a respectable yield of around 5% from his rental properties. This provides him with a healthy £130,000 gross a year in retirement.

So how is that taxed?

Unfortunately, all of his earnings are taxable as income. This means James’s income will be over £125,140. As a result, James loses his entire tax-free personal allowance and every penny is taxable. The first £37,700 is taxed at 20% and the next £92,300 is taxed at 40% – James will pay a total of £44,460 in tax.

Olivia

Olivia is also taking £130,000 gross in retirement, from roughly the same value of assets. She’s done pretty well for herself, just like James, and has £1 million invested in a pension; £1 million invested in an ISA; £300,000 in a general investment account and just under £135,000 in a bond.

Now, 25% of Olivia’s pension can be accessed tax free – c. £250,000. She takes £10,000 of her pension as tax free cash (TFC) on an annual basis, so it will last throughout retirement. She then takes a further £50,270 from the pension each year. It is only this £50,270 that will be taxable as income, so Olivia will have her full tax-free personal allowance of £12,570, and the next £37,700 is taxed at 20%.

She then takes £50,000 from her ISA, which is completely free of any tax. Next, she accesses £12,300 a year from her general investment account (GIA) using her tax-free annual capital gains tax allowance. And finally, Olivia can take 5% of her bond every year tax deferred so takes the final £7,430 from here, to make up the full £130,000.

It is important to emphasise that this is basic tax planning. If you’ve been following, you may have noticed that Olivia receives £92,300 a year completely free of tax. In fact, she only pays an annual total of £7,540 in tax.

What does this mean? Well, over ten years, our property investor will pay £369,200 more in tax. It’s astonishing!

Overall, I’m not saying that property is all bad, as there can be great reasons to hold it as part of a diversified investment plan. However, please ensure you consider the tax you might pay when calculating your potential return. Ultimately, if your objective is to save tax, you should probably work with a financial planner instead.

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