Look into investing for rental income in the UK, and you’ll invariably be told to purchase your buy-to-let property through a limited company.

Old property codgers and young influencers are united: it’s a no-brainer.

Well, perhaps senility is setting in at Monevator Towers, but I don’t see the case for acquiring a buy-to-let property through a limited company as completely clear cut.

At least, not for me. And probably not for all of you.

I’m thinking here of people who’d invest in just one or two buy-to-lets (BTLs) to create an income to help fund their (early or other) retirement.

Sure, if you’re a budding property mogul (like every second YouTuber it seems) then build out your BTL empire through limited companies.

Similarly, if you’re a high-earner and hence a higher-rate tax payer and you expect to stay that way – maybe even into retirement – then yep, No Brains Required. A limited company is the best choice.

But everyday escapees from the 9-5?

The likes of my co-blogger, The Accumulator, who aims to sustain him and his missus on an annual income in the £20-something thousands?

In that case there are pros and cons.

Owning a BTL in your name might actually be a better route, as we’ll see.

Why own rental property?

First a quick summary of why you’d invest in a buy-to-let for income.

Here at Monevator, we focus on the liquid, low-hassle advantages of shares, bonds, and their various fund incarnations.

However it’d be silly not to see how valuable a rental property can be.

Indeed in most corners of the UK and in the media – where property appears to be ‘my pension’ under some ancient Trade Descriptions Act – the argument hardly needs to be made.

For millennia, give or take the odd rough patch, the rich stayed rich by owning property (and land) and charging the common oiks for using it.

A skim through The Sunday Times Rich List shows little has changed.

It’s not easy to get wealthy via real estate, starting from scratch.

But as a way of preserving wealth got some other way, it’s tough to beat.

In the UK, property prices have mostly been rising since World War 2, even after adjusting for inflation:

Source: Economics Help

Lots of people are angry about this, of course. But that’s for another day.

The point is while it’s subject to fluctuations like all risk assets, residential property has – over time – preserved (and grown) spending power.

Better yet, let out your property to tenants, and you can expect the income you receive to rise, too:

Source: Office for National Statistics

True, rents have softened recently in some cities, thanks to the Covid pandemic. But short-term fluctuations aren’t the point with property.

Real estate is a long-term asset. Prices and rents have risen faster than inflation for generations.

Buy a decent property with fair rental potential, and you can reasonably expect to enjoy a rising income throughout your retirement years.

It’s not all kerching!

Before the peanut gallery gets going, let’s agree there are other factors to consider with rental property.

Tenants can be a hassle. Houses can fall down. And do you really want to be refitting a two-bedroom flat on the sixth floor in your seventies?

But this article isn’t about all the issues with buy-to-let. I’m just pointing out that rental properties have appealing characteristics. Bought right, they can play a role in a diversified retirement income strategy.

Personally, I’d always consider a mix of different assets. Rather than devolving down to the usual Internet stance of A Is Good but B Is Evil.

There are many ways to skin a cat, as they say (although I can only think of one ghastly method. Pretty horrid, even if you’re not the cat.)

With an open mind, let’s crack on!

The BTL boom

Buy-to-let used to be so easy, as Simon Lambert noted back in 2015:

… £1,000 invested into buy-to-let in 1996 would be worth £14,900 at the end of 2014. 

It comfortably beat all other assets. The same £1,000 invested in shares would be worth £3,119, while a cash pot grew to £1,959.

ThisIsMoney, 16 April 2015

In the 1990s, City boys with bonuses and 50-somethings paranoid after pension scandals found they could deploy newly-competitive BTL mortgages to outbid first-time buyers for the proverbial two-bedroom flat.

Finance the purchase with an interest-only mortgage, rent it back to the poor sods you priced-out, and boom!

Literally. UK house prices soared.

Lots of new landlords got legions of renters to finance growing portfolios of buy-to-lets. If you weren’t worried about a price crash (alas I was) then the economics of leveraging up even as rental yields fell were compelling.

It all got a bit embarrassing for politicians. Governments like high house prices, but the affordability argument was becoming impossible to ignore.

Conservative politicians were torn between promoting home ownership and the perception that it was becoming concentrated in fewer hands.

That didn’t matter at first – landlords being more a Tory’s natural constituency than public sector renters, say – but the numbers got silly.

Why limited companies are even a thing with buy-to-let property

Thus it was oddly enough a Tory government that began to turn the tide.

Various bungs to help first-time buyers get into the market and compete with landlords were extended. (Whether sensibly or not.)

And a more hostile environment for landlords came into being.

Within just a few years an additional stamp duty rate for the purchase of second homes was introduced. Capital gains tax breaks on BTLs you’d previously lived in were harder to qualify for. And – slowly, but most significantly – the economics of using a mortgage to finance a buy-to-let were squeezed. Hard!

In Ye Good Old Days, a landlord set all of their mortgage interest payments on a BTL against the rental income. They only paid tax on what was left.

But since April 2020, landlords cannot set any interest expenses against rent. Instead there’s a tax credit worth 20% of the interest payments.

This is bad for higher-rate taxpaying landlords using mortgages. It means much higher tax bills and a lower net income.

The tax maths as a higher-rate tax-paying BTL owner

Let’s suppose that higher-rate taxpayer Bob gets £1,000 a month rent on his BTL and his mortgage interest expenses are £700.

Prior to the new rules, Bob could have set his annual interest-only mortgage cost of £8,400 against his £12,000 of rental income.

That left £3,600 in profit, of which £1,440 went to tax (levied at 40%) and £2,160 ended up in Bob’s pocket.

Today, however, Bob is liable for tax on the £12,000 of rental income at his highest rate of 40% – so £4,800. He is only able to reduce this with the 20% tax relief on the £8,400 interest payments, which equates to a £1,680 credit.1 This means £3,120 goes to HMRC.2

Bob still has his mortgage interest to pay, so his total costs are £8,400 plus £3,120 in taxes. Deducting both from the £12,000 income leaves just £480 in Bob’s bank account. (And that’s ignoring all Bob’s other expenses).

A dramatic collapse in net income from £2,160 to just £480.

Note that if Bob was a basic-rate taxpayer, nothing has changed. Under the old system he’d have paid £720 in tax.3 Under the new system, basic-rate Bob has a £2,400 tax liability, but gets the same £1,680 tax credit. Hey presto: £2,400-£1,680 = £720 tax to pay, as before. Bob’s net income would be £2,880.

Tax under limited company ownership

When a limited company owns rental property, it’s treated like any business with income and expenses. This means the entire mortgage interest cost can be set against the rental income (again, along with various other expenses, which I’m ignoring for simplicity).

Corporation tax is paid on the resultant profit.

This makes a rental property owned by a limited company a much more lean, mean profit machine.

For example, let’s assume for now all the numbers stay the same. (In practice expenses would likely be higher with a limited company).

Income of £12,000 minus £8,400 in interest payments leaves £3,600 profit. At a corporation tax rate of 19%, that sends £684 to HMRC, leaving £2,916 in net profits.

On the face of it a stellar slam dunk for limited company ownership! But keep reading. (Spoiler: It’s more complicated.)

Other pros and cons of purchasing a buy-to-let property through a Limited Company

These tax changes are why BTL landlords have rushed to set-up limited companies (or SPVs4 as they like to call them. It’s just a sexier name for a limited company with a relevant tax code).

But there are other advantages – and disadvantages – to owning and letting out property this way.

Advantages of owning BTLs in a limited company include:

• Profit being taxed at lower corporation tax rates, as above.
• Some mortgage providers may be satisfied with less onerous stress tests on a property’s ability to cover the mortgage (but should you be?)
• In theory you have limited liability, since it’s the company not you that owns the property. However you’ll probably have to give personal guarantees to get a mortgage, and directors can be sued, too. Also many landlords take out comprehensive insurance against mishaps, anyway.

There are also disadvantages to going down the limited company route:

• Limited company mortgage interest rates have fallen, but rates are still higher than the best personal BTL rates.
• You’ll probably need to use an accountant, and do more paperwork.
• That will add extra expenses to running your rental property.

It’s worth noting too that a limited company still has to pay the extra 3% stamp duty payable on additional homes. So you’re not dodging that.

And corporation tax is rising, as per the March 2021 Budget. The limited company advantage might theoretically be trimmed.

The new 25% rate will only begin to be phased in for businesses with profits over £50,000, though – which will exclude the vast majority of ordinary landlord’s portfolios. (For the time being, anyway).

End of story? Not for basic-rate taxpayers

By now you might think owning a BTL through a limited company has an unassailable edge, even for the humblest landlords in retirement.

Income is the point, right? And on the face of it, limited companies clearly chuck out more cash.

However in some circumstances that might not be the case.

Remember my note above that the tax changes didn’t alter the economics for basic-rate tax payers?

Well that might be a throwaway side-note for high-earners looking to build out chunky rental portfolios.

But for basic-rate taxpayers – such as a great many retirees, especially FIRE5 devotees who pull the plug early – it’s a very big deal.

My sums above showed limited companies deliver higher cashflow at the per-property level.

But you must extract the money from the limited company to spend it!

And it’s here the picture gets more nuanced for basic-rate payers.

You might get a higher income than if you own your BTL through a limited company

This is not something those empire-building property gurus focus on. Good luck to them, but know that using a limited company for one or two properties might actually result a lower income for you.

The issue is that corporation tax isn’t the end of the story.

When you come to remove money from your company – as you would if you were living off the rental income – you’d normally do it as a dividend.

Depending on your other sources of income, there could be dividend tax levied at:

• A basic-rate of 7.5%
• A higher-rate of 32.5%
• Or even 38.1% if you’re a retired oligarch paying the additional rate

You do get a tax-free dividend allowance of £2,000, which helps.

But remember dividends from other sources (such as shares held outside of shelters) count towards that £2,000 allowance.

We saw that as a private landlord, basic-rate taxpayer Bob paid only £720 in tax and got an income of £2,880 from his BTL.

If Bob had acquired his BTL inside a limited company, we’ve also already seen the company would have been left with £2,916, after corporate tax.

Now let’s say Bob extracts this as a dividend, and is able to use his full dividend allowance. In his case £916 is liable for tax at 7.5%, which means £68.70 goes to HMRC and Bob is left with £2,847.

That’s slightly less than he got as a private landlord.

Worse, if Bob had already used up his dividend allowance elsewhere, his net income falls to £2,697.

The net income from the limited company would probably be even lower still in practice. Bob would have accountancy bills to pay of £1,000 or so a year, albeit these are also expenses that will reduce corporation tax.

All told, it’s not hard to see the annual income after expenses and taxes from the limited company falling towards the £2,000 mark.

Other complicating factors

I could give other examples that made things look better or worse.

The important thing is to apply the numbers to your own situation.

When you do so, there are other issues you need to consider.

Most importantly, rental income might push you into a higher tax band.

This is especially important if you’re not using a limited company, since the full rental income is going to be added to your income from other sources.

With a limited company, you might want to make payments into your own pension, which is a more tax-efficient way of getting the money out.

Indeed, in either scenario, an early retiree will likely have various income levers to pull.

For example you might reduce the drawdown from your SIPP to keep your pension income plus rental income below key tax thresholds.

There’s also the usual opportunities for shenanigans for couples involving who owns what.

But this post is already insanely long, and I can’t cover every scenario.

The point is to think carefully about what you hope to get out of any rental property, and where you are in life.

Then run the numbers for yourself.

Two’s not a company, but three or four…

With all this written, I would probably invest in buy-to-lets through a limited company if I ever go down this path.

That’s because if you don’t intend drawing the income for a long time, it’s definitely more tax-efficient to keep the profits inside the company.

Retaining more profit means more money to put into your next purchase.

Also, the more rental properties you own, the more you spread the limited company hassle factor – and your accountancy fees, too.

And if you want to invest with other people, you’d best do it through a limited company (or possibly a limited liability partnership, but please do your own research on that). It’ll be the proper way to structure it, legally.

Finally there may be estate planning advantages with limited companies. Consult your professional advisors if that’s a factor for you.

Know your limits

I suspect the government wants to see the whole rental sector inside limited companies. That way it can better monitor – and regulate – what’s going on.

So maybe things will get even harder for landlords operating outside them.

What’s more, even if you only intend to own one or two rental units, you might unexpectedly become a higher-rate taxpayer further down the line.

Moving existing BTL properties into a limited company will be an expensive pain. So you may decide it’s better to start that way.

Fair enough.

But if you are on the cusp of retirement and you just want to buy and let out a flat or two to add £500 a month to a fairly modest retirement income, I’m not sure it’s worth the bother.

Do your own sums though, and figure out what works best for you.

Many readers have lots more experience with property than me, and I’d be interested in your insights. Remember my modest use case: I agree you should always acquire a larger portfolio of buy-to-lets through a Limited Company, or if you’re a higher-rate payer. Also let’s please minimize the landlord name calling and predictions of property Armageddon, for the sake of a good discussion. Thanks!

1. £8,400*20%. [↩]
2. £4,800-£1,680. [↩]
3. £12,000-£8,400, then taxed at 20%. [↩]
4. Special Purpose Vehicles [↩]
5. Financial Independence Retire Early. [↩]

Who needs to make back-up plans when you’ve spent a decade writing about and otherwise pondering living off a portfolio in (early) retirement?

Surely I’ve thought of everything!

I mean, in part one of this series I outlined my decumulation plan in excruciating detail.

And part two saw me thrill you with an explanation of how I’ll use a dynamic system to manage my asset allocation and determine what we can withdraw to live on each year.

In short, I’ve put more thought into this than anything in my life before.

But what if I’ve miscalculated? Or what if we face market conditions that out-disaster any historical catastrophe?

Then we’re fu-

…then we’ll turn to Plan B.

My A-F of back-up plans

The ultimate plan B in decumulation is our house.

The Investor convinced me years ago that it’s rational to think of your house as an asset, even though that’s difficult emotionally.

If I really have to, I can convert my home’s estimated sale price into X years rental income, or X months in a care home.

Alternatively, it could provide an income injection via equity release.

We have other back-up plans, too.

Our State Pensions and Mrs A’s small DB pension are Plan C. These don’t come on stream for years but I haven’t included them in our SWR, so they’ll be a bonus when they do.

Plan D is working for money from time to time.

I want the option of never needing to work again. That doesn’t amount to a religious vow never to work again.

I’m happy to work on projects I think will be challenging in an enjoyable way. I just want the freedom to choose, and to walk away if need be.

Mrs Accumulator will also maintain part-time hours for now.

It’s good that we’re both keeping our hand in to some extent. Even a small amount of income takes huge pressure off our portfolio in the early years. This reduces the chance of us being forced back into the labour force from a position of weakness.

Plan E is annuities. At some point in our seventies there’s a good chance the mortality credits will make them a worthwhile hedge against longevity risk and portfolio volatility.

Annuities get a bad press. They make people bristle psychologically. Near-zero interest rates don’t help, but annuities are still a useful tool if you’ve got a long lifeline.

On that tip, Professor Moshe Milevsky, who’s done ground-breaking work in this area, recommended a biological age test as a way of taking a bearing on your longevity.

Check out his appearance on the excellent Rational Reminder podcast.

Just do it already

Plan F? I believe I covered that one at the start of this section.

You can’t escape the rat race by creating an adamantium-plated decumulation plan. You’ll never leave the grind.

I can conjure any number of phantoms if what I secretly want to do is to stay chained to my desk.

And whatever happens, I’ve still got my wits.

(“Oh dear. We’re fu-” – Mrs Accumulator)

The inflation problem revisited

The thing that almost keeps me up at night is inflation. It can be ruinous for unlucky retirees.

There are a couple of inflation beasties hiding under rocks that require consideration, beyond the threat of a reckless future government doing a ‘Weimar Germany’ or revisiting the stagflationary 1970s.

One is that your personal inflation rate doesn’t track CPI-inflation, nor even old granddaddy RPI.

There is in fact no chance that your personal inflation rate tracks the headline inflation rates exactly. So it’s worth getting a handle on it before you head into decumulation if your budget is relatively tight.

If our personal inflation rate goes wildly off-piste (which it has done in the past) then we’ll need to rein it in. Nominal asset returns and pension cost-of-living adjustments don’t give two hoots for our personal rate.

The second issue is hedonic inflation, which we’ve been warned about by Monevator reader ZXSpectrum48k.

Official measures of inflation don’t accurately measure rising living standards, as opposed to rising prices.

Nobody thought a mobile phone was a basic necessity 20 years ago. Or the Internet 30 years ago. Or anti-lock brakes on your car back in the Dark Ages.

ZX’s point is headline rates of inflation understate the prices we actually pay for items that are subject to hedonic adjustment, like a computer.

Technically the price of computing has plummeted in the last 25 years. Except that I pay more every time I upgrade, because my computer displays more colours than I can comprehend, and is so thin I could cut a house invader with it.

Maintaining your standard of living on this measure is under-researched (in fact I haven’t seen any research) and it could easily knock another percentage point off your SWR.

Which kinda drains the colour from my face.

No inflated expectations

I don’t want to end up like my gran who couldn’t afford a car until one of her sons was able to give her his.

On the other hand, my parents don’t understand the fuss about mobile phones. They have one each but they forget to charge it, or turn it on, so you think they must be dead.

They certainly haven’t found it necessary to figure out how mobiles work, despite having all the time in the world.

Then again, I can see why my retired parents, wafting around in full control of their personal agendas – and without any pressing need to be hyper-connected – don’t see smart phones as a fundamental human right.

Not every rise in living standards improves quality of life for everyone.

So while I’ll be gutted if I can’t afford the immortality drug available in Boots from 2045, I’m hopeful that we’ve got enough flexibility in our decumulation finances to afford those things we do need.

I see this problem as a chance to focus on what really matters. It’s just not worth spending another decade in the office trying to make ourselves bullet-proof.

We’ll live with less later if it means living more now.

Back-up plans aren’t foolproof

Do you trust your numbers? This is a psychological question more than a financial one. Decumulation looks like a high-wire act in comparison to the comparative cakewalk of accumulation.

Ultimately, you have to pick the numbers that let you sleep at night.

My decumulation plan is predicated on historical withdrawal rates crash-tested by two world wars, The Great Depression, and the turmoil of the 1970s. I find that pretty comforting.

Fair enough, I haven’t prepared the stables for the Four Horsemen Of The Apocalypse.

My plan won’t cope with:

• The breakdown of society
• World War III
• Fascist coup / Communist revolution / The rise of the robots / A takeover by the Tufty Club.

I guess I’ll just have to take my chances.

Wish me luck!

Take it steady,

The Accumulator

What caught my eye this week.

Rishi Sunak didn’t hike capital gains tax in the Budget. I took it a little personally after I’d voluntarily conjured up a five-figure tax charge, partly fearing he’d double the rate I’d pay.

However I’m not too miffed.

For one thing, the unsheltered shares I sold were mostly of the MAD GAINZ variety that did ridiculously well in the pandemic. And these growth stocks have continued to be hammered since I sold.

Indeed at one point on Friday my former highest-flyer only needed to slip another 5-6% for me to be up on selling even after the future tax charge.

Alas, it bounced into the close. Bittersweet.

Another reason is I still have more capital gains to deal with in the future. Bitcoin, anyone? Though that one could well take care of itself in time, given its mercurial record.

Anyway, remember to always invest in an ISA or SIPP to avoid this nonsense.

Beyond the Budget

The more worrisome reason I’m not too upset that I sold is some pundits believe big changes could still arrive on so-called ‘Tax Day’.

That’s set for 23 March.

According to the Financial Times [Search result]:

A Treasury decision to hold a “tax day” three weeks after the Budget will be a bellwether for long-term changes in government tax policy, including on capital gains and environmental levies.

My standard policy has been to mostly ignore clickbait articles about this or that tax break being set to get the chop. Fearmongering comes up every year, and most of the time nothing much happens.

However we know the UK will have a harder time balancing the books in the future, thanks to Covid. Freezing personal allowances and nudging up corporation tax in the Budget was meaningful, but will it be sufficient?

Here’s all the Budget blues news:

• Key Budget points at a glance – BBC
• More main points from Rishi Sunak’s Budget speech – ThisIsMoney
• How to prepare for what comes next [Search result] – FT
• What was in the small print? – Which
• Extra 1.3m will start paying income tax over next five years – Guardian
• Sunak claims Budget measures will create ‘Generation Buy’ – Guardian
• How the government’s new 5% deposit mortgages will work – MSE

Have a great weekend all.

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