An ISA Alternative to Buy-to-Let
Many Buy-to-let investors will just have filed their 2017/2018 tax return, the first tax year where the new income tax relief changes are starting to bite. The full impact of the changes will be phased in over the coming 3 years and only be fully felt from the 2020/21 tax year. But already it is becoming clear that, whilst historically Buy-To-Let investing has for many been a source of retirement income, going forward it is becoming more of a (leveraged) bet on house price growth. With the ISA season coming up, maybe this would be a good time to consider a tax-efficient Individual Savings Account (ISA) as an alternative to Buy-To-Let.
Why an ISA?
Unfortunately, picking one or several properties as a buy-to-let investment, with a mortgage attached to it, is not really “as safe as houses”. It is a leveraged investment, highly dependent on the performance of one or a few very specific assets. This doesn’t really fit with what most investors want to from their retirement savings. Most savers want to be able to sleep at night, not having to worry about their investments. And that’s before we mention call-outs for broken boilers or heating.
In an ISA, investors can choose from a broad range of investments, including funds and trusts. These tend to have no gearing or leverage and are often very diversified. For those who still want to invest in residential property, there are funds and trusts available that invest in UK residential property. Instead of picking just one or a few homes, such funds tend to spread their investments across dozens or hundreds of residential properties across the UK, reducing the overall risk. Also, the manager is effectively the landlord, and takes care of tenant management and maintenance.
In addition, an ISA is tax efficient. The annual allowance for a “Stocks and Shares” ISA is £20,000 and any income or capital gains are tax free. Plus, there is no need to declare an ISA on the tax return.
ISAs have a further benefit for investors. Instead of making one big lump sum payment, investments can be made over a period of time, for instance with a regular monthly contribution, which reduces the risk of buying at the wrong time. Something that is particularly relevant when markets are as unpredictable as they are at the moment.
What has changed for Buy-To-Let investors?
Record low interest rates since the Financial Crisis made investing in residential property with a mortgage highly attractive, resulting in a strong rebound in house prices following 2008/09. This led to concerns about house price affordability, in particular for first time buyers. As a result, the Treasury introduced two significant tax changes.
First, new legislation added an extra three per cent to the stamp duty bills of those buying a second property from April 1, 2016.
Second, the historically attractive mortgage tax relief is being significantly reduced between 2017 to 2021. Until April 2017, landlords could deduct all of their mortgage interest payments before calculating their tax bill, meaning they would be taxed on their profits rather than their overall turnover. From the April 2020-2021 tax year, mortgage interest tax relief will be fully replaced by a tax credit limited to the basic rate of tax (20%).
Whilst the higher stamp duty creates a one-off hit, the changes to tax relief impact Buy-To- Let investor’s income on an ongoing basis, in particular for higher rate tax payers investing with a mortgage. As an example, someone earning £1000 per month in rent, with a £600 mortgage interest payment, will see their annual post-tax income halfed from £2,800 to £1,400.
What are the implications?
For many, a buy-to-let property has historically been a saving that earns an income for retirement, with the potential added benefit of capital growth. Net income from such investments will now be much reduced for many. Adding the potential risk of some extra maintenance cost, or properties being empty for a period, such investments are likely to lose their appeal as reliable income generators. What remains is a leveraged play on house price growth.
Therefore, it might be time to have a good look at whether buy-to-let investing still is the retirement saving of choice, or whether an ISA could be a more suitable, tax-efficient and hassle-free alternative for investors.