Pensions vs Property; which is the best investment

Which is the Better Investment; Pension or Property?

It’s not uncommon for people to invest in property as their little nest egg for retirement. For some, property is seen as a safer option in the long run compared to the volatility of financial markets which affect pensions.

In fact, a recent YouGov poll found that 30% of respondents between the age of 45 and 54 were considering using their retirement funds to invest in property. 

There are pros and cons to each option which is why the pension vs property debate is one which has been raging for years. We’ll take a look and weigh up the differences between investing in property and investing in your pension.

Upfront Costs and Fees

One of the first things to consider is any costs and fees associated with investing in property or pensions. There’s no getting away from it, you will encounter them no matter which option you choose.

Pension Fees

Costs associated with investing in your pension include fees paid to your financial adviser (if you have one), management fees and transaction fees. They aren’t entirely avoidable and could add up over time to make a substantial outgoing.

It can be argued, however, that these fees will make your money work harder in the long run – so you could see a better return on the investment. This is especially true if you make use of an independent financial adviser, which we would always highly recommend. You are paying for their time, knowledge and years of experience which will help you lead the comfortable retirement you dream of.

Property Costs

Let’s face it, buying property isn’t cheap! The biggest outgoing here is obviously the purchase of the property. On top of that, you have the survey cost, solicitor’s and estate agency fees and potentially stamp duty to pay.

Running costs

The costs incurred with property don’t stop once you have made a purchase. Becoming a landlord comes with a number of responsibilities which includes making sure the property is in tip top condition. This means you could be slapped with a bill for a new roof, replacing a broken washing machine or replacing inefficient windows.

Now, insurance will help a way towards this but there will still be monthly premiums to pay and excess for the claim (depending on your policy).

Tax Considerations

Tax can be a big contributing factor to whether a pension or property would be the best option for you. You should take into consideration not only the tax which you will be charged at the beginning of your journey but also the end.

Tax implications of investing in your pension

By their very nature, pensions are designed to be tax efficient. This is to encourage more people to put money aside to fund their retirement.

You get tax relief on all contributions (20% for basic rate, 40% for higher rate and 45% for additional rate). Which, in practice, means if you are a basic rate taxpayer, paying in £100 will only cost you £80.  

When you reach the age of 55, you can take 25% of your pot as a tax-free lump sum, if you so desire. But remember, you do have to pay tax on any withdrawals you make beyond the first 25%.

Tax implications of investing in property

Unless you are a first-time buyer, or the property costs less than £125,000, Stamp Duty and Land Tax must be paid. If you are purchasing a second property as your buy-to-let investment, you’ll have to pay an extra 3% on top of your appropriate Stamp Duty band.

Any rental income is subject to income tax. The first £1,000 you make on rent is tax-free as this is your ‘property allowance’. Anything above the £1,000 is chargeable.

If you choose to sell the property in the future and make a profit, Capital Gains Tax may be due. If you don’t, the property becomes part of your estate and, when you die, will have its own tax implications. Which leads us on nicely…

Inheritance Tax (IHT)

As we have just mentioned, any property you own makes up part of your estate – whether that is the home you live in or a buy-to-let property. When you pass away anything within your estate will be subject to IHT. If you have assets worth more than £325,000, you’ll be subject to an IHT tax rate of 40%.

Pensions are typically exempt from IHT, although there are some restrictions. Money taken out of your pot, but not spent upon your death will count towards your estate and therefore will be subject to IHT. With the exception being – if you die before 75, the person who inherits your pot (within two years) will not pay tax on it.

Exposure to Risk

When it comes to finances, a lot of decisions balance the risks involved with a particular investment vs. the potential return. This risk isn’t necessarily always weighed up by looking at the full picture, however. A lot of people will get their information and insight from the news.

In the past, any news report about pensions have often had negative connotations. In contrast, news stories about property have tended to be talking about price rises which is a more positive outlook. 

If people are only seeing bad news about pensions, they are less likely to trust them or feel inclined to invest into one. Whereas property will look a lot a lot more enticing.

In reality, there is a risk with investing in both your pension and property. Let’s take a closer look.

Risks of investing in Property

Investing in property does come with a few risks. The big ones being:

  • There is no guarantee that the value of the property will rise over time. This means you may not see a return on your investment if you choose to sell.
  • Your rental income could be outweighed by the costs you incur.
  • If you borrow money to buy property, you could find yourself in negative equity during difficult times.

There have been a number of regulatory and tax changes recently which may mean buy-to-let isn’t as lucrative to individual landlords with just one or two properties. There is also no guarantee that regulations and tax won’t change again in the future.

If you’re thinking of investing in property, do you have an exit strategy? There may come a time where you don’t want or need to have income from a property. If possible, you will want to have a property in a great location which will attract great tenants and is also more likely to rise in value overtime.

Risks of investing in a pension

Investing in a pension isn’t without risk either. As pensions are tied in with financial markets you may not get back as much as you put in. With a pension this is unlikely due to the amount of time you are investing your pot. However, you could find that if your pension doesn’t grow as much as you had hoped meaning you could run out of funds during your retirement, especially if your funds don’t grow in line with inflation.

There are ways to mitigate this concern. There are products on the market which guarantee you a monthly income during retirement. These are known as annuities and are bought with cash from your pension pot (we have written about them here). This option could give you peace of mind that you will receive a monthly income for the rest of your life, no matter what happens to the financial markets and with inflation.

The thing to remember with pensions, is your money is spread across a number of assets in a number of sectors. This means if any of them should suffer, your other investments should balance out any losses.

With a pension, you only invest the money you have, so you can’t lose more than you have invested. Plus, pensions now have so many safeguards such as charge caps and money held in trusts and they are regulated by the FCA so much of their bad press in the past has been addressed and reconciled.

Funding your Retirement

Rental income

One of the main reasons why people choose to invest in property for their retirement is to provide themselves with a regular income. For those who choose to enter the world of buy-to-let, they ultimately rely on the rental income they can achieve.

With this in mind, the main aim would be to get the highest rental yield possible to make the investment profitable.

Rental yield is calculated by dividing the annual rental income by the amount invested in the property. According to some experts, a good yield would be anything above 7-8%. It needs to be high enough to cover all costs such as; mortgage payments, repair and maintenance, agent’s fees, insurance and tax. For the investment to support you in retirement, you would still want to have a good amount of profit left over after all costs have been paid.

There are calculators available online to help you work out what rent to charge to get the best yield possible. But remember, at the end of the day, your rental yield will be determined by what the markets will bear. If you want to charge above the odds to get a higher monthly income, you will probably struggle to find a tenant who is willing to pay.

Pension Income

Since the pension freedom rules were introduced in 2016, it has made drawing income from your pension much easier. In some cases, you can start taking a monthly income whilst leaving your fund invested to provide you with further growth over the long term. With a bit of luck and good planning, your fund will grow and replace some of the income you have taken, so your capital remains intact.

Seeing a return on your investment

The key to a successful investment is the value of the return you see, obviously, the higher the better. House prices have beaten inflation by 3% a year since 1955, the UK stock market has grown at double that rate (these figures exclude rental and dividend yields).

With buy-to-let property, you can benefit from capital appreciation as well as rental yields, while stock market investing can give you share price growth plus dividends.

A few extra pros and cons

Phew! As you can see, there is a lot to take into consideration when choosing between investing in a pension or property. Here’s a brief overview of some of the main points we covered, plus a few more pros and cons to consider:

Pros

Pensions:

  • By contributing to a workplace pension scheme, your pension is getting an extra boost from your employer. That 3% minimum additional contribution can really help to boost your pension pot over time.
  • If you start saving early, compound interest means your pot could grow significantly before you reach retirement.
  • Although its highly recommended to review them regularly, you could simply pay in your regular amount to your pot and forget about it. No stress and no one else involved (unless you want them to be
  • Your money is invested in a diverse portfolio of assets, spreading your risk. Unlike having all your eggs in one house shaped basket.
  • Your pension is protected by the FCA if your provider is regulated (always choose an FCA regulated product). There’s no need to worry about losing your hard-saved money if your provider goes bust.
  • Contributions are flexible. Feeling flush? Pay in more. Struggling for a bit? Drop your payments down. Withdrawing from your pension is also flexible. Whether you chose to withdraw a lump sum, buy an annuity or draw some down there is an option to suit everyone.
  • Pensions are viable with tax planning. Speak to your financial adviser for more information.

Property:

  • You are guaranteed a monthly income whilst your property is let out to a tenant
  • You own real assets. Some people prefer to have solid investments so they can see exactly where their money is.  
  • Although they do fluctuate, property values are on a long-term rising trend. This makes them a relatively safe long-term investment option as you could benefit from capital growth and make a healthy profit when you come to sell.
  • You can offset some of the cost against tax, such as; interest on buy-to-let mortgage repayments, fees paid to lettings agents and paying for repairs.

Cons

Pensions:

  • There are restrictions on accessing your pot of cash. Your money is locked in until you reach 55.
  • There is no guarantee of performance. Investments could fall as well as increase and if your pension scheme is performing badly as you approach retirement, this could cause you a lot of stress.
  • Some may find pensions complicated. With so many options available to you when you reach retirement, it can be difficult to know which option is best for you.

Property:

  • If you are unfortunate enough to have less than favourable tenants, you may be open to more risk. Missed rent payments can put a strain on your finances and leave you out of pocket. Consider that there may also be periods of time when your property sits empty – you will still need to pay the bills whether you have a tenant or not.
  • There is a lot of responsibility in keeping the house in good condition for your tenants. As you reach your golden years, you may not want the hassle. Of course, you can arrange for an agency to look after your property for you but there are additional costs associated here.
  • Your money is tied up in the long term and is not quick to access should you need it. If you decide to sell your property, there can be a very long time between putting it on the market, finding a buyer and then reaching completion.
  • You’re committed to certain number of outgoings a month. Mortgage payments are inflexible and running costs could keep rising.

Still not sure? Speak to your financial adviser

We understand that there is a lot of information to take in here, and it may have left you with more questions. We would always recommend speaking to your financial adviser before you make any decisions about planning for your retirement. 

They will discuss your long-term goals with you and help set you on a path that will help you get there.

If you would like to find out more about pensions, check out our other useful articles or read up on how we can help you. Alternatively, get in touch with a member of our friendly team, we would be happy to arrange a meeting.

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