Wealth Check: 'I want to buy a new flat and pay for a decent pension'
Saturday 16 April 2005
Paul Walker, 31, technology consultant
Salary: £79,000 including benefits and bonus
Loan: £16,000 at 5.9 per cent
Property: Wants to buy a flat
Savings and investments: £6,000 in cash ISAs, £9,000 in stocks and shares ISAs, £3,000 in premium bonds, £18,000 in other cash savings (an internet account earning 5.5 per cent), and £7,000 in an M&G index tracker fund.
Pension: Contributions of about £350 each month.
Monthly outgoings: Paul needs cash for socialising at weekends and eating out. He takes two holidays a year and some city breaks but has no other big spends.
Paul Walker would like to buy a flat in central London in the next year. He has some reservations about the housing market being overvalued and would also like clarification about rules surrounding transferring property into a fund.
He seeks a flat in the region of about £300,000 - he has £30,000 towards a deposit, which he nearly used to buy an apartment in Rio de Janeiro last year, but he didn't see one that he liked.
Paul makes pension contributions of 4 per cent of salary, which is matched by the company. He has been contributing for 18 months. He adds an additional £100 a month and wonders if this is sufficient. Additionally, he has two years of pension contributions in a fund in Australia, where he has permanent residency, but doesn't think he can repatriate this fund to the UK.
We put Paul's case to Paul Willans at Mazars Financial Services, Paul Ilott at Bates Investment Services, and Andrew Merricks at Skerritt Consultants.
If Paul wants to keep the Rio dream alive, Andrew Merricks says he could consider a 100 per cent mortgage for the London flat, such as the two-year, fixed-rate deal costing 6.19 per cent with Northern Rock. The loan would cost him £1,967 a month. The rates for 100 per cent loans are larger than for smaller loans. With his £30,000 as a deposit, the monthly payments on a two-year fixed rate of 4.99 per cent with Cheltenham & Gloucester would be £1,559 each month.
Paul Willans warns that by tying up all his assets in his property, Paul would be heavily exposed to rising interest rates. Although a fall in house prices could wipe out his equity stake, he may decide this is a long-term purchase of a home, rather than an investment. In this case, he should focus on his monthly commitment and choose a mortgage limiting his interest costs in the short term.
Paul Ilott says investing in residential property, using your pension fund, will become possible from 6 April next year, when new pension reforms take effect. But he warns pension savers to think carefully before investing in residential property it is unlikely to produce the sort of returns seen over the past five years.
If Paul lives in the flat, he will have to pay marketable rent into his pension fund, as he will be judged to be directly benefiting from the use of the investment in his pension. It is treated as a "benefit in kind" under taxation rules: in short, he will have to pay more in income tax. The benefit-in-kind rules will not apply if he rents to a third party.
Paul's pension planning appears to be on track, says Merricks. Although, it is always easy to make an argument for putting more in, at Paul's age, Merricks would support contributing to an ISA with excess funds, rather than putting them into the tax-efficient, yet inaccessible, pension fund. He can add lump sums to the pension at later dates.
Willans says Paul is right to consider additional investment in his retirement planning, but he may need to scale this back if he buys a property. As a single person, he needs to insure his largest asset his future income against long-term sickness or disability.
Willans says that assuming Paul is going to keep some of his ISA funds after the property purchase, he should think about how to achieve good diversification. He may wish to consider the suitability of his M&G Tracker Fund, where the sole aim is to track the fortunes of the FTSE All Share Index, in favour of a managed fund.
Ilott suggests Paul considers repaying his £16,000 loan, as, although 5.9 per cent is low, repayments still account for £944 of his after-tax income. As a higher-rate taxpayer, he would need his savings accounts to generate before-tax interest equivalent to 9.83 per cent a year in order to match the after-tax return he would get by repaying his loan.
Paul's investments are fairly tax-efficient and cautiously managed, says Ilott. As a higher-rate taxpayer, Paul is obviously keen to prevent personal income tax and potential capital gains tax liabilities, but Ilott would urge him to consider having at least a small exposure to more aggressive actively managed stock market funds.
Paul's M&G Index Tracker is the type of fund that performed well during much of the 1980s and 1990s, but the investment environment is now quite different, and more active funds have the potential to perform best. A fund like this would also compliment Paul's tracker fund because the patterns of returns are less likely to coincide with one another.
For a free financial check-up, write to Wealth Check, The Independent, 191 Marsh Wall, London E14 9RS, or e-mail firstname.lastname@example.org.
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