Funding your retirement: Pensions or property?
Published: 13 September 2016
Whether pensions or property offer a better basis for funding retirement is a longstanding debate that divides opinion.
Around the turn of this Century, while final salary schemes were closing, stock markets were wobbling and the reputation of the pensions industry was being tarnished by scandal, property values were increasing rapidly.
The housing market slowdown that followed the financial crisis took the heat out of the argument for a while. But it was reignited in August when Andy Haldane, Chief Economist at the Bank of England, said property “was almost certainly” a better bet for retirement planning than a pension.
“As long as we continue not to build anything like as many houses in this country as we need to ... we will see what we’ve had for the better part of a generation, which is house prices relentlessly heading north,” said Haldane.
Both pensions and property have their advantages, of course, as well as their fair share of drawbacks. Here’s a rundown of the main pros and cons of each:
The case for pensions
A few simple steps can make a big difference to the nest egg you can build up. They include: saving regularly and diversifying across different asset classes. Some of the tax incentives in pensions may have been watered down in recent years. The lifetime allowance for pension savings has been reduced for example. But the tax benefits of pensions are still significant. You get tax relief on your contributions at your marginal rate, up to your annual allowance or your earnings if lower. You can withdraw 25% of it tax-free after 55. And if you save into a workplace pension you may well benefit from employer contributions matching your own to a certain extent.
The charges on modern pensions are typically lower than on older policies. They are highly likely to be well below the costs associated with buying and maintaining a property. Most pension plans also offer a range of different asset classes and funds to invest in, making it easier to diversify and potentially reduce risk while aiming to generate long-term growth.
Pensions are also affordable to most people. The Alliance Trust Savings Self Invested Personal Contribution has a minimum contribution of £50 for example. The auto-enrolment rules for employer pensions are also boosting participation levels for pensions at a time when first-time buyers face a formidable challenge securing a foothold on the property ladder.
There are downsides, of course. The tax advantages of pensions are at the mercy of politicians, with speculation seemingly forever surrounding the sustainability of tax relief at its current levels. Some commentators also believe the Lifetime ISA being launched next year could be a step on the way to a different form of retirement saving.
The investment risk of pensions is one that some people may be uncomfortable with. Reforms in 2015 have also introduced more flexibility around taking money out of pensions. This has made the decision-making process at retirement a potentially more complex one.
Free guidance about retirement options is available from the government backed Pension Wise service. Plans are also in place to let people take £500 out of their pension savings tax free to pay for personal advice. But in some cases the decisions to be made may demand a level of advice that people may be unable or unwilling to access.
Pensions at a glance
|Pension pros||Pension cons|
|Significant tax benefits||Tax benefits could change|
|Relatively low charges||Lifetime ISA more flexible?|
|Ability to diversify investment risk||Complex retirement decisions|
|Affordable minimum contributions||Costly advice may be needed|
The case for property
People like property because it’s solid - they can touch it and they can physically own it (although for most people it will be partly owned by a mortgage lender). Property also benefits from a supply-demand feature that currently supports both house prices and rental income, as Andy Haldane pointed out.
The rental yields from buy-to-let can seem especially attractive for older investors seeking a regular income. Rental incomes in the first half of 2016 were 1.5% up on the same period the previous year, according to BM Solutions, with rental yields above 6% in areas including Scotland, Northern Ireland and the North and North West of England (although that rental income doesn’t account for costs such as fees). Rental yields in London were the lowest, yet still averaged 4.5%.
Those yields are supported by rising rents, a trend that seems likely to continue as factors including low interest rates and a shortage of affordable housing help push house prices up. Higher prices are seen to support the case for banking on the sale of a property to provide funds in retirement. Almost a third of people approaching retirement would prefer to use property wealth to fund retirement before using their pension fund, according to research last year by Consumer Intelligence.
The potential pitfalls are clear, however. Anyone relying on house price inflation to fund their retirement is vulnerable to a housing market slump that hits both capital growth and their chances of realising a profit by selling.
Meanwhile the appeal of buy-to-let has dimmed, with the introduction of the 3% surcharge on stamp duty (or 3% surcharge on Land and Buildings Transaction Tax in Scotland) for buy-to-let and second homes. The UK government is also phasing in a reduction in the amount of the level of tax relief on buy-to-let mortgage interest payments.
Property has its fair share of costs too, not only on purchase but also relating to maintenance, tax and letting.
Property at a glance
|Property pros||Property cons|
|It’s a physical asset that can be enjoyed not just as an investment||All eggs in the property basket|
|Rental yields can help meet income needs for older investors||Capital growth and chances of a realising profit could both be affected by a market slump|
|Supply and demand is currently pushing prices up||Relatively high purchase and maintenance costs|
What’s the answer?
The pensions or property debate tends to overlook one very important point - that it doesn’t have to be one or the other. Property investments can be particularly effective when used alongside other pension investments, helping provide the diversification that any portfolio needs.
Property ownership doesn’t have to be bricks and mortar either. Investors can access collective funds and trusts that invest in commercial property. These still offer a low correlation with asset classes such as equities and fixed income (meaning they tend to be affected in different ways by market events). From real estate investment trusts and property unit trusts to shares in listed property companies, the indirect investment options are varied.
Some people will invest in property both directly and indirectly, inside pension wrappers and outside. Property can play a big part in a diversified retirement portfolio that also includes pension investments.
It doesn’t have to be either/or.
Important informationThese articles are designed to help investors make their own investment decisions. They do not constitute a personal recommendation to invest. If you have any doubts as to their suitability you should seek expert advice. Please be aware that the value of investments can fall as well as rise so you could get back less than you invest.
Your existing pension may have valuable benefits which you might lose when you transfer.
Laws and tax rules may change in the future without notice. The information here is our understanding in August 2016.This information takes no account of your personal circumstances which may have an impact on tax treatment.
Past performance is not a guide to future performance.
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