How the 3+1 Plan works
In my last article, I introduced you to Sean and Kate, whose property investments changed their child’s life. The parents of the soon-to-be law student used a simple strategy to invest in a buy-to-let property. The capital gain on that property will more than cover their daughter’s degree education.
They now want to leverage the equity they have in the investment property to fund their retirement. They have around 25 years to go until their official retirement dates but would like to retire sooner if possible.
In this post, I’ll outline the 3+1 Plan, a simple property investment strategy that promises financial freedom in your retirement.
What is the basis of the 3+1 Plan?
The 3+1 Plan simply uses our actual spending patterns to produce a self-financing property portfolio.
If you think about how you spend your money today, you spend around:
- a third on your mortgage or rent;
- a third on taxes (income tax, VAT, council tax, and so on); and
- a third on living.
Now transfer this concept to the buy-to-let properties you purchased in the 3+1 Plan. Every tenant will spend around a third of their income on rent. Your buy-to-let finances might look something like this:
Let’s say that you have three properties each valued at £200,000.
- Each one rents for £830 per month (£10,000 per year).
- Your entire mortgage is £400,000, costing you £16,000 per year in interest (at 4%).
- Your management and maintenance fees total £6,000 per year.
- Your gross income from your property portfolio after all these expenses is around £8,000.
Now, £8,000 (before income tax) isn’t enough to live on, but it will certainly help pay the mortgage off on your home. How much earlier do you think you could pay off your mortgage if you had an extra £5,000 or more every year?
When can you retire?
When you can retire under the 3+1 Plan depends on three factors. The first of these is how quickly you can pay off your mortgage. The second is how much your buy-to-let properties appreciate in value. Finally, it depends on how much income you want in retirement. Now I’m going to make three assumptions here:
- You’ve repaid your mortgage in 20 years.
- Your property portfolio doubles in value every ten years. (Actually, historically property prices have doubled in the UK every 7 to 10 years for the last 80 years and more. By taking ten years as our doubling period, we’re erring on the cautious side.)
- You want to retire on the same disposable income you had the day before you retired and repaid your mortgage.
Repaying your buy-to-let mortgages
Using the assumptions above, in 20 years your property portfolio will be valued at £2.4 million. (The value doubled after ten years and then doubled again after another ten years.) Each property is worth around £800,000. Your total mortgage is still £400,000.
So what you could do is sell one property for £800,000, and pay off your mortgages of £400,000. Of the £400,000 remaining, you’ll have to pay some capital gains tax. If you’re a basic rate taxpayer when you retire and based on today’s rate of capital gains tax, your CGT bill will be around £160,000.
So you now have around £240,000 as a lump sum to do with what you will.
Remaining income
Now, you have two properties remaining, each valued at £800,000. Let’s say they are yielding a gross rental income of 5%. That’s £80,000 per year – or around £6,650 per month.
After property management, repairs and maintenance, and other costs, you’ll probably be left with around £5,000 per month (and this is a conservative figure). This is a before-tax number.
What will your income before retirement be?
Let’s say that your current income before tax is £3,000, and that your salary increases by 3% every year for the next 20 years, when you plan to retire.
At that point, immediately before you retire, your gross salary will be approximately £5,418 per month.
Congratulations, you’ve replaced your income in retirement
Your mortgages are all paid on your investment properties, and you’re left with an income of around £5,000 per month.
Immediately before retirement, you were earning £5,418 per month. But from this, you had to pay the mortgage payments on your home.
The net effect is that you can now afford to fully retire, with your income entirely replaced. Is a pension plan likely to offer you the same potential returns?
Options for your retirement
Of course, you might decide not to sell the third property. Instead, you might refinance and continue to pay mortgage repayments. Or you might choose to sell altogether and draw down the lump sum as retirement income. The point is that you’ll have plenty of different options available to you at retirement. All because of you putting into action one of the most simple, straightforward, and effective investment strategies available today: the 3+1 Plan.
Of course, the above is an illustration only. Like all illustrations, it makes some assumptions. To talk about your personal situation, and how the 3+1 Plan could work for you, contact Gladfish today on +44 (0)207 923 6100. The sooner you start, the sooner you’ll be able to retire and enjoy your life.
Live with passion
Bret Alegre-Wood
