Financial Planning for Buy to Let Portfolio Landlords

Bricks and mortar is a popular investment route in the UK. It provides many families an extra source of income during working life and their main source of income during retirement. A buy to let portfolio can form part of an effective financial plan however there are some considerations to be mindful of.

Firstly, all rental property, even within a limited company, forms part of the owner’s estate. This means when this property, or the company shares, pass down to children, it is liable to a 40% Inheritance Tax (IHT) charge for any value exceeding the Nil Rate Band. Mortgages can be used to reduce this liability, however, given most people expect to live beyond 80, mortgages will likely be paid off by the time most people pass away. If there is more than 1 property, this IHT liability can end up being quite large as the estate includes all assets excluding the pension and shares qualifying for business relief.

There are two solutions to this problem. One is to take out a whole of life insurance policy to cover any IHT liability. This ensures that when the parents pass away, the children do not need to sell the property to pay off the liability, allowing the assets to pass down a generation. All policies should be placed into trust to avoid proceeds forming part of the estate and to ensure quick access to the proceeds.

The second is to gift the property, or company shares, during lifetime. It takes 7 years for the gift to fall outside the estate, so it is wise to consider gifting in early to mid-retirement to ensure the gift is completely outside the estate before death. After the gift is outside the estate, then any whole of life policies may be cancelled.

There are three considerations with gifting. One is to make sure all mortgages are paid off by the time the property is gifted, and two is to make sure that any rental income to the settlor ceases once the property is gifted. This is to ensure the settlor does not fall foul of the Gift of Reservation rules, which means if they benefit in any way from the gift, then the property would fall back into the estate. The third consideration is to plan for the reduction and eventual cessation of this rental income. This ties in with the final point.

As with any good investment strategy, one should diversify their asset base and not depend entirely on one asset to provide all future gains and income. In this case, one should consider investments into tax efficient wrappers such as ISAs, Pensions and Investment Bonds which will provide the income and lump sums needed when the rental income stops. It is best to illustrate this with an example.

In the first scenario, the client has decided not to gift his buy to let portfolio. One can see that he retains the benefit of the rental income until death, shown by the pink colour running across the cash flow graph below. However, upon passing away his children’s IHT liability is circa ￡4.1 million.

In this second scenario, the client has gifted the property at 70 ensuring the gift is outside of his estate when he passes away, reducing the IHT liability to circa ￡1.1 million, a substantial difference. The gift is shown by the yellow spike in the middle of the graph below, and the end of the pink colour which represents the cessation of rental income. This client has avoided shortfall in future cashflow which may easily be caused from the rental income stopping by making use of ISA and Pension allowances during his working life. The light blue and orange colour represents the income provided by the ISA and Pension, respectively.

To summarise, buy to let property is a popular route to provide a passive income, however, to integrate it into a truly effective financial plan, one needs to consider:

1. Protection while holding the property for mortgages and eventually IHT.
2. Gifting the property in early to mid-retirement to reduce potential IHT.
3. Using tax efficient allowances like the ISA, Pension, and Investment Bond to diversify assets and replace rental income once the property is gifted.