Wealth check: Landlord plan could be flawed, experts warn

An energy consultant wants to boost the power of his savings with a buy-to-let, but would he be better off sorting his debts first?
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The patient

Russell Turner, 34, is saving to get on to the first rung of the property ladder. But that's no easy feat in Brighton, where prices are high despite the credit crunch and recession. He is renting a room in a two-bedroom house where he pays £500 a month including bills. He can easily afford rent as he earns £55,000 a year as an energy consultant.

Russell hopes to buy a two or three-bedroom house in the city over the next few years. "I will probably rent this out to students and save any excess income to put towards renovating the house to a higher standard so I can get back on the market," he says. "Or alternatively, I might buy a property in need of renovation that I can live in and do up."

By being frugal with his spending, and with some help from his parents, he has managed to slot a substantial sum away. He has £30,000 in a NatWest savings account paying 2.75 per cent – or 1.65 per cent after higher-rate tax.

However, he has some credit card debt to tackle, with £2,400 on an Egg card at a hefty rate of 26.9 per cent. "I checked this a few days ago and I'm amazed to see how much I'm paying on this and how the rate has risen," he says. "When I opened the account in January 2006 the rate was around 16 per cent. I thought that once the rate is agreed, that is what you'll pay."

He also has £2,300 on a Post Office credit card at 16.9 per cent, although he is chipping away at both these card debts by repaying as much as possible. "I allow myself £1,000 a month spending money, and the remainder goes towards paying off my credit card debt." Otherwise, Russell has no debt.

Before buying his first property, he intends to do his research and hopes the market may have further to fall before he takes the plunge.

Russell isn't making any contributions to a pension scheme. "I don't really worry about retirement," he says. "It may sound morbid, but my father died of a heart attack at age 50 and I haven't really worried about what I'll do when I'm 70 as I don't think I'm going to live that long." Russell has no protection policies in place.

The cure

There are several steps Russell can take to improve his financial situation according to our panel of independent financial advisers (IFAs). For starters, he should explore more tax-efficient ways of boosting his savings.

Savings and Investments

Transferring a portion of his cash savings into an individual savings account (ISA) to reduce the tax liability on the interest would be a sensible move for Russell – particularly as a higher-rate taxpayer. "Using this savings vehicle will save him 40 per cent on any interest earned," says Chris Wicks from IFA N-Trust.

He can immediately transfer £3,600 into an ISA this year and slot away a further £5,100 from April next year when the available allowance increases. However, the best rates on the market at present involve tying up cash for five years. "This is too long in Russell's situation," says Dennis Hall from IFA Yellowtail Financial Planning.

There are other accounts to pick from. One of the most attractive is from Manchester Building Society paying 3.01 per cent with a notice period of 25 days on its Premier ISA. People who invest in the stock market should be prepared to tie money up for five to 10 years. As he wishes to buy a property, he should stick to cash savings for the meantime. Once he has grabbed the first rung he should focus on building a diversified portfolio of investments.

Debts

It is "crazy" for Russell to be paying such hefty rates of interest on his credit card debt while having savings earning a paltry sum in comparison, stress the advisers. Their advice is to use some of this pot to repay his debt. Russell should also think about how these debts were built up in the first place, says Danny Cox from IFA Hargreaves Lansdown. "They might have been for specific purchases or gathered over time. But he should focus on controlling his spending, as credit card debt in particular can become a dreadful ball and chain and spiral out of control."

Property

Relying on buy-to-let as a long-term investment strategy is a "flawed plan", warns Mr Hall. These mortgages are currently expensive, with arrangement fees typically at 2 per cent to 3 per cent of the loan. "He would need a sensible business plan to go down this route," adds Mr Cox. "And should bear in mind that income from buy-to-let is subject to tax, although expenses can be offset." Also, when the property is sold, any profit above the annual capital gains tax exemption – £10,100 for 2009-10 – is subject to CGT at 18 per cent.

In comparison, a residential mortgage is generally cheaper with lower fees. At present, lenders are likely to require a deposit of 15 per cent to access a decent rate, says Mr Wicks, compared to about 25 per cent for a buy-to-let mortgage. In addition, if the property was Russell's home, there would be no CGT tax to pay when he sold. He could take advantage of the rent-a-room scheme, enabling him to earn a tax-free £4,250 a year, says Mr Cox. If the income is higher, costs can be offset against the income.

Russell may be wise to wait before buying, says Mr Hall. "That might fly in the face of the recent upward tick in property prices, but that is more a supply and demand issue that could eventually turn again."

Retirement and protection

Even if Russell avoids saving into a pension, he shouldn't bury his head in the sand when it comes to long-term retirement planning. "Medical advances in the past 10 years mean that many more people survive things like heart attacks, and tend to live longer," says Mr Hall. "So even if he doesn't choose a pension, he should consider long-term savings options such as stocks and shares."

However, if Russell has the opportunity to join an employer's pension scheme he should do so to maximise the potential of any employer contributions and, perhaps, other benefits as well, agree the advisers.

He could also consider a low cost self-invested personal pension (Sipp), says Mr Cox. This will see a £60 contribution boosted to £100 by the Government for higher-rate taxpayers, and he will be able to access his fund from age 55.

Without financial dependants, Russell has little need for life cover, but he should ask his employer how long he will continue be paid if he is sick for an extended period.

As his family has suffered health issues, and as a worthwhile safety net, the advisers suggest he consider an income protection policy to provide a replacement income in the case of long-term illness or disability.

Do you need a financial makeover?

Write to Julian Knight at the Independent on Sunday, 2 Derry Street, London W8 5HF j.knight@independent.co.uk

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