When we talk about retirement, it’s not uncommon to hear people say, “My property is my pension”. But what do they mean by that and is that even possible?
The Capital Growth Myth
The UK property market has grown exponentially for some time, with growth outstripping inflation by 3% per year since 1955.
However, the UK stock market has performed even better over the same period, with investors achieving more than 6% above inflation on average.
Both are based purely on price and don’t take yields, rental or dividend, or other costs, maintenance or transaction fees, into account.
Emotion vs Logic
The process of downsizing is not one many people look forward to when the reality of it hits them. Moving out of their home, abandoning its memories and perhaps having to leave their community and friends. What about space for the grandkids to stay in the new smaller place? On top of this they need a buyer, and many young people are struggling to save enough money for a deposit, so there are no guarantees. Logically, it makes sense. Emotionally, it is a lot harder to do.
Buy – To – Let
It can be an all-or-nothing investment that usually means you have to invest a large deposit outright, with the rest funded through a mortgage which is paid of gradually. These mortgage payments can be heavily affected by interest rates and if the Bank of England raises rates, homeowners with variable or tracker mortgages will see their repayments rise too.
A mortgage gives you leverage, which amplifies potential gains if the property increases in value. But this works the other way too and potential loses are amplified also.
Unlike stock market investments that can be sold down over time if you need money, property does not offer easy access to your money and will prove a far more complicated process to release cash.
Moreover, the government is increasingly targeting the buy-to-let market for tax revenue. On top of the increased stamp duty for second home purchases they are introducing new tax rules that may chip away at any returns.
The changes are shifting towards not being able to offset interest costs against the money you make in rent for income purposes. You’ll get a 20% tax relief on the interest payments instead. It’s a gradual change which will be fully phased in after April 2020.
Rental Income vs Dividends
With buy-to-let you get ongoing rental income alongside changes in the value of the property. With the average UK rental yield around 4.3%, this gives you an income with the prospect of additional profit over the long-term.
The FTSE All-Share also currently offers a prospective dividend yield of 4.4% variable, not a reliable indicator of future income.
Of course, both yields are averages. Properties in certain parts of the UK are likely to generate a much higher yield, just like certain businesses that are listed on the stock market can offer higher dividend yields than others.
Time vs Money
You’re free to sell your house whenever you like, with the option of investing that money somewhere else. You might have to pay 18% or 28% in capital gains tax (CGT) on any increase in the value of the property.
Any gains in a pension are free from CGT, but you can’t usually access it until 55 (57 from 2028). At this point, up to 25% is usually tax free and the rest you’re free to take how you like, but it will be taxed as income.
Property can be time-consuming and requires a lot of effort. Finding tenants, handling the bad ones (and their pets). Dealing with letting agents, arranging (re)mortgages, maintenance, repairs, decoration, and insurance. Buying and selling is costly and can also be drawn-out.
If you have more than one property it is like running a small business.
A pension on the other hand is pretty relaxed, and in our opinion should be the first thing most people consider for their retirement saving. You just need to check up on your investments to make sure they’re still right for you.
Every UK resident under 75 qualifies for tax relief, even children and other nontaxpayers.
When you add money, you get a boost from the government of up to 45% (46% if you’re a Scottish taxpayer). It’s one of the most generous tax perks available and the main reason so many people put money in a pension in the first place.
Remember, tax rules can change, and benefits depend on personal circumstances.
Unfortunately, most traditional pensions don’t give you a lot of investment choice. Certain types of pension, like a SIPP (self-invested personal pension), let you choose your own investments from a large selection.
A SIPP also makes it easy for you to manage your pension. You can see how it’s doing online, making changes whenever you like, and ultimately determine how you enjoy your retirement.
Property Vs Pensions – who wins?
It’s not a case of one being better than the other. Both have their advantages and disadvantages and what’s right for you will depend on how comfortable you are with their risks. Investing is all about distributing money to benefit from a decent return at some point in the future, and there’s no reason property and pensions can’t complement each other as part of a diverse investment portfolio.
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