The truth about investment opportunities and retirement

Investment Property can be overlooked as a retirement option, but jumping to such conclusions could be costly.

In this article, I’m going to look at the story of two twin brothers, Paul and James, who both inherited £20,000 in 1996 when they were aged 40 years. They each decided to do something very different with their inheritance, but with the same goal in mind: to semi-retire when they were 60.

James’s story – stock market returns and tax advantages

James spoke to his financial advisor. He explained his ambition and decided that he would put the entire sum into a personal pension rather than investment property. He was a higher rate taxpayer at the time, and so claimed full tax relief on his contribution. By doing so, his total investment wasn’t £20,000, but £28,000.

The pension fund was benchmarked against the FTSE 100 Index. All his dividends were reinvested, and all capital growth was tax-free. His financial advisor had pointed out how well shares did in the long term. As this was a long-term investment, James was convinced that investing in the stock market was the best action.

As the years went by, James watched the value of his pension pot move up and down. He was happy that when the market fell his dividends were able to buy more shares. His fund fell quite dramatically in the early 2000s, when the dot-com bubble burst. Then the stock market recovered. The same happened in the mid-2000s when the Global Financial Crisis hit the world economy so hard.

A pension that’s not quite enough to semi-retire

Now, 20 years after the original investment, he sits down to review his pension portfolio with his financial advisor and discuss his options. He has done really well, he’s told.

The FTSE 100 Index is only 47% above where it stood when James invested, but his fund has performed much better. His financial advisor explains that the tax advantages of investing in a pension fund have really made a difference. The financial advisor calls it “the ultimate total return” – all the advantages of dividend reinvestment, but with none of the tax.

From that original £20,000 inheritance, James’s pension portfolio is now valued at a little more than £77,000. Even though he is only 60, he can take his pension in several ways. For example:

  • He can take a 25% tax-free lump sum (£19,250) and a reduced pension; or
  • He can take a full pension by buying an annuity. On his £77,000 fund, this works out at approximately £4,600 per year.

Nothing for his children to inherit

James could take his pension, but It’s not enough to semi-retire. If he were to die while receiving the maximum pension, there would be nothing left from the fund to pass on to his children. It doesn’t seem quite as good as the financial advisor says.

Paul’s story – an investment property bought with a loan

Paul had never earned as much as his brother and had always paid tax at the basic rate. Instead of investing in a pension, Paul decided to put his money to work by buying an investment property.

He used the £20,000 inheritance as a near 40% deposit on a house valued at £50,930. His mortgage, at 7.5%, cost £2,319 per year. Fortunately, his lettings agency and property manager found a really good long-term tenant, who paid £340 rent per month. After paying property management fees, maintenance and repairs and the like, Paul was left with a tiny profit. And he had to pay tax on that.

Those first couple of years were hard, but Paul kept his head above water. The rental income just about covered the mortgage and other costs. He’d had a void period when one tenant left leaving the property empty for a short while. By and large, though, he was happy.

Four years after he made his investment, Paul’s rental income had increased to £5,450 per year (£450 per month). His mortgage payments had decreased, thanks to cuts in the interest rate. For a couple of years, he had benefitted from positive cash flow on his investment and had begun to reduce the outstanding mortgage amount.

In 2004, he had his investment property valued. At this time, his rental income had increased to £545 per month. His mortgage rate had been reduced to just 6%, and his mortgage payments were just £150 per month. He was ploughing every penny of profit into reducing the mortgage as quickly as possible. When the property valuation came through, it told him that his investment property was worth more than £152,000.

Catching the property investment bug

Paul decided to buy a second investment property. He took some equity out of the first property to fund a deposit of £52,000. His total mortgage payments now were £10,290 per year. He used the same property manager to manage the second property. In total, his rental income was just over £13,000. After management fees and maintenance, Paul was breaking even on his investment properties.

Today the story is a little different. Paul was helped massively by the interest rate reductions after the Global Financial Crisis. The interest rate charged on his buy-to-let mortgage is now only 3.5%. He has had to pay some tax as his cash flow position steadily increased. During the last ten years, Paul has used any profit after tax to pay down the capital owed on his buy-to-let mortgage.

Semi-retired with a legacy to leave

Paul’s properties were recently valued at £197,000 each. His mortgage outstanding is £150,000. After mortgage payments, property management fees, maintenance and other charges, Paul is left with around £10,000 of gross income per year. He has now semi-retired.

And if Paul were to die, his children would inherit two income-producing properties worth a total of nearly £400,000, with no mortgage – he’s got life insurance to cover that.

An average story for those buying investment property

The story of Paul and James shows how much better investment property is likely to perform over the longer term. However, the twins’ results have only been in line with the average over the last 20 years. But you can see that if you:

  • do your research on property investment properly;
  • invest to make a profit and not concentrate on trying to make money by eliminating tax; and
  • benefit from great property management services,

then your capital gain and income are likely to blow stock market investment out of the water.

By buying property, Paul invested much more profitably than his brother. He is earning more than twice the income his brother’s pension investment would pay. It is only an average result, based on average returns and average property price increases over the last 20 years.

Our aim is to help clients do even better than the average − as did Kristina, a property investor who has seen her investment property in Wembley increase in value by £60,000 in just six months. If you’d like to be more like Kristina and Paul, and less like James, contact the team at Gladfish today.

Have a chat with us on +44 207 923 6100 today and find out how our Set and Forget property strategy works.


Ritesh Patel

Ritesh Patel
August 14, 2018

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