Funding your retirement is what you’ve spent your life working towards. Investing in pensions and property are both ways to fund it, and both have advantages and disadvantages. This week, Nick Rolf weighs them up.
The property market has proven remarkably robust in recent decades. Occasional slumps usually only last a few years, and most investments are likely to prove worthwhile in the long term. Indeed, some investors have even amassed property portfolios worth millions.
Despite the current volatility, the buy-to-let market remains bullish – demand continues to outstrip supply. You are likely to get a rental income… and meanwhile, the value of your investment will be growing, so you will enjoy a sizeable profit when you eventually sell.
There is some risk involved. Returns are usually very good… but they are by no means guaranteed. You need to factor in a plethora of ancillary costs, such as insurance, repairs and maintenance. And then there are tax considerations and agency fees. Will the capital growth be sufficient to make it all worthwhile? You might find yourself having to hang on to your property for longer than you would like in order to leverage any profits.
The biggest problem with property… is extracting money from it! It can take months or even years to sell, so you might need a backup plan if you are intending to use it to fund your retirement.
If you want to live off the rent alone, you might also need to consider what will be left once you have made your monthly mortgage payments.
Flexibility is also an issue. You can't simply drop an extra dollop of money into a property – you have to invest in terms of tens or even hundreds of thousands of pounds. So developing your portfolio is not straightforward – unless you are extremely wealthy.
Some people take tens of thousand pounds out of their pension pot and pile it all into a buy-to-let property. However, raiding your pension pot can have major implications and can even lead to tax penalties.
Although property prices have recently fallen at their fastest rate for over a decade, buy-to-let still has some advantages: it will give you some rental income and you'll hopefully get capital growth as your property increases in value over time.
But there are disadvantages: your profits will be somewhat eroded by the large amount of tax you may have to pay, there is always the risk of property prices falling, reducing your capital in the process and forcing you to sell for less than what you bought it for, and there are maintenance costs and insurance to consider. And that's before you've even thought about stamp duty or capital gains tax. Oh – and you’ll be a landlord: that’s a headache you might not want during your retirement years!
It’s worth remembering that landlords are affected by a number of recent tax changes. Until 2015, for example, landlords could offset mortgage interest payments against rental income, but this is no longer the case. Over the past six years, the tax relief landlords could claim has been completely phased out. It has now been replaced with a 20% tax credit – nowhere near as beneficial for higher-rate taxpayers. There are also capital gains tax implications.
Put simply, a pension is a long-term investment plan with added tax relief. Most pensions nowadays are defined contribution schemes, but there are also salary-related defined benefit schemes in the public sector. Both have tax benefits, making them more efficient than any other mainstream investment product.
If you have a self-invested personal pension (SIPP), you have more control over the types of investments you can include in it. You can even include a commercial property in your SIPP. So essentially, you do not have to choose between pension or property – you can invest in one by using the other.
The most obvious one is that you have to wait until you are 55 before you can access it (and this is expected to rise to 57 in 2028). You should talk to us if you think you are going to need additional funds before you are that age – we can help you set up other easier-to-access investments.
Again, there is a measure of risk involved: your pension will be invested in stocks and shares, which are subject to all the volatility of the markets. But the good news is that tax relief adds a healthy bonus, significantly offsetting the risk. And as you get older, it makes sense to reduce the risk of any last-minute losses by moving your pension into less risky investments.
Most of the risk is associated with drawdown schemes. This involves your pension investment remaining in the stock market even once you have retired. Obviously, we can help you mitigate this risk.
You get tax relief when you pay into your pension. Once they are in there, the investments in your pension are protected against capital gains tax and inheritance tax.
As far as property and taxation are concerned, the rules are becoming less generous. When you buy a property, you pay stamp duty, as well as conveyancing and survey fees. And don't forget: a residential property in addition to your primary residence incurs an additional 3% stamp duty charge. That's on top of the normal rates that apply for primary residences.
Then you have to pay tax on any income from your buy-to-let rental. You declare it on your self-assessment tax return, and it is charged in accordance with your income tax banding. If the value of your property has risen by the time you come to sell it (which you will be hoping for), there will be capital gains tax to pay.
For most people, when it comes to taxes, pensions usually win.
Inheritance Tax usually doesn't apply when you pass on your pension pot. This is because, unlike other investments, your pension plan isn't normally part of your taxable estate.
That's why it can be tax-efficient to keep your pension savings invested within your pension plan and pass them on to family members or down to future generations. In addition to the potential savings on IHT, you may also get tax benefits on any future investment returns.
For the first time in years, property price growth is looking decidedly sluggish. The result is that buy-to-let carries more risk than it has done for a long time. Suddenly, the threat of negative equity is back in town.
A defined contribution pension is not connected to your employer, so will not suffer if your employer goes bankrupt. Needless to say, it is subject to volatility in the same way as the rest of the stock market. But over a long period of time, growth is more likely to be positive than negative.
How do property investments and pensions compare? Until recently, property values have been skyrocketing, generating enormous gains. However, changes in the way in which property is taxed may prevent us from seeing those kinds of gains resulting from rising house prices in the future.
You are unlikely to end up with less than you have put into a pension. But all investment carries a measure of risk.
What people really want to know when they ask this question is whether or not they can use their house to fund their retirement. Remember, a house is not a pension (pensions qualify for tax relief, houses do not). There is nothing terribly “liquid” about property. Converting it into spendable cash is no mean feat – particularly if you are currently living in it. Basically, your money is sequestered in bricks and mortar.
Equity release, however, is an option for funding your retirement. This involves turning some of your home's value into cash while you are still in it. Many people will have paid off their mortgage by the time they retire, so they will have 100% equity. But there are implications of releasing the value stored up in your home. It reduces the amount your beneficiaries stand to inherit after your death, for example. And some of its value is paid to the provider of the equity release plan. Sometimes, this arrangement can be to the detriment of the homeowner.
Pensions have numerous advantages over property, including tax relief (money back from the government), employer contributions (in the case of most workplace pensions), lower volatility (as they invest in a broad range of assets), and greater accessibility and flexibility.
That does not necessarily mean that property investment can’t fund your retirement. You just need to be aware of how the two approaches compare so you can make an informed choice.
For most people, a pension is the most straightforward option. But really, it will all depend on your own personal circumstances. For extremely wealthy people, property might actually be the better option. At the same time, the new lifetime allowance rules have made pensions more attractive for very high earners.
We can look at the overall structure of your finances to see how best you should distribute your money in order to get the best tax benefits.
