The Wire: Autumn 2021Pension or property – what’s the best way to fund your retirement?

(Estimated read time 5 minutes)

Pension or property – what’s the best way to fund your retirement?

Saving into a pension has long been the standard method of building up a retirement fund. It might be through a self-invested personal pension (SIPP) or perhaps even through an employer-sponsored scheme.

However, with the seemingly inexorable growth in residential property value over the last couple of decades, many people see a buy-to-let property portfolio as a potentially lucrative alternative to a pension.

Both pensions and property have their advantages and disadvantages when it comes to saving for retirement. Here are some of the pros and cons to help you consider the relative merits of each.

Advantages of buy-to-let property

It’s not just rising property values that can make buy-to-let an attractive investment proposition.

It’s easy to understand

Compared to the potential intricacies of pensions, buying property is straightforward and easy to comprehend. Most people do it at some stage.

Rising property value has long been the staple of dinner-table conversation. If you’re conscious that you’re sitting on an asset that’s appreciating in value, why not invest in the same market?

There’s a demand for residential property

As well as providing an opportunity for growth, rising property prices have also created the scenario that feeds it. Price growth has outstripped income growth, which means that many are stuck in a trap of needing somewhere to live but not being able to afford to buy.

According to HomeLet, the average rent in the UK is now at a record high of £1,029, up 6.6% on the same time last year.

The ongoing decline in the availability of social housing stock has also created a market for private letting.

Additionally, the increase in numbers going into further education has also helped fuel the demand and create buy-to-let opportunity in university towns and cities.

You also receive regular income

Once you’ve taken costs, such as mortgage repayments, agency charges and ongoing upkeep of the property into account, it’s highly possible to generate a regular monthly income. This is in addition to any capital growth in the underlying value of the property.

Downsides of buy-to-let property

Alongside the benefits, you should also consider the downsides of buy-to-let before deciding to proceed down this road.

Initial costs can be substantial

The immediate up-front costs of property purchase can eat into your capital.

There are estate agent fees to consider, as well as the legal and survey costs associated with property purchase. You also need to consider Stamp Duty, and the 3% surcharge you’ll pay on top of the standard rates payable for buy-to-let property.

There are also likely to be furnishing and other costs when it comes to making the property suitable for letting, and potential costs for bringing the property up to a satisfactory level before you rent it.

There are ongoing costs to consider

As well as the initial costs, a rental property can also saddle you with ongoing costs.

Both regular and ad hoc maintenance are likely to be required, and you’ll need to pay fees to a letting agent unless you’re happy managing the property yourself. These can exceed 10% of the monthly rent.

If you are unlucky to attract the wrong tenant the maintenance costs and or legal costs if it becomes litigious can be substantial.

On top of that, rental income is treated as earned income and therefore liable to Income Tax at your marginal rate. If you are a higher or additional rate taxpayer the ability to offset mortgage costs to reduce this taxable income has gradually been reduced over the last few tax years. From now on there will effectively be no higher rate or additional rate relief on mortgage interest costs instead you will receive a credit for the basic rate tax only. It is estimated that the additional tax raised this year by these measures will be £1.3 billion.

There are disposal costs

When you come to sell the property, you’ll have to take estate agent costs into account again.

Also, you’ll potentially face a Capital Gains Tax (CGT) bill when you sell a property that isn’t your main residence. If you’re a higher- or additional-rate taxpayer, you’ll pay CGT at a rate of 28% on the profits made from the sale of a buy-to-let (over and above your annual exempt amount of £12,300).

You’ll incur cost when the property is empty

All your buy-to-let calculations will be predicated on receiving a monthly income. But what if the property is empty for an extended period? You’ll still need to pay any mortgage and will also be responsible for ongoing utility and insurance costs – even if there is no rent coming in.

Property values can fluctuate

The rise in residential property value seems inevitable, but all bubbles tend to burst at some stage. External factors – such as local development – could also see a decline in property value.

Remember, property is not a liquid asset. Unlike investment funds, a house or flat can’t necessarily be sold quickly. It can take months or even years to realise the value of an asset.

The benefits of pension investment

There are good reasons why pensions are the most popular option when it comes to saving for your retirement.

Pensions are flexible and easy to set up

A new pension is remarkably simple to set up. Online access means you can arrange a new account and start paying money into it within just a few minutes. It’s also never been easier to establish a self-invested personal pension (SIPP) or small self-administered scheme (SSAS).

Since 2015, pensions have been remarkably flexible when it comes to how and when you can take   money out of your fund once you get to age 55 (rising to 57 from 2028). Ad hoc amounts and regular income are easily accessible.

As well as taking money out, contributions into your fund can be equally flexible with providers accepting both regular contributions and single amounts.

There are attractive tax incentives

The government actively encourage you to save for your retirement by providing generous tax incentives on your personal contributions. As an additional-rate taxpayer, every £1,000 contribution to your pension costs you just £550.

That’s significant immediate growth, even before your funds are invested.

There are a wide range of investment options

There are, literally, thousands of different funds to choose from when it comes to investing your money.

Investment managers offer a choice of funds across all market sectors, with both passive and active investment strategies.

As you go through your journey to retirement you can switch and manage your investments to meet your aims and ensure your investment profile is appropriate.

The downsides of pension investment

Before you start saving into a pension, you should be aware of the potential pitfalls.

Your money can be at the mercy of markets

Data shows that stock market investment will generally provide you with growth in the long term, but fund values can fluctuate, dramatically at times, and the value of investments can fall as well as rise.

There are limits when paying in and taking money out

The quid pro quo when it comes to tax incentives on contributions is that you’re limited on the amount you can pay in tax-efficiently.

Annual contributions are limited to either £40,000 gross, or the amount you earn – whichever is lower. And, if you earn more than £312,000 a year, the Tapered Annual Allowance reduces your tax-efficient savings to just £4,000.

When you start drawing money flexibly from your fund, that limit also falls to £4,000.

You will also be subject to the Lifetime Allowance – currently £1,073,100 (2021/2022 tax year) on the total value of your pensions. Any income taken beyond this threshold could result in you incurring an extra tax charge.

You’ll incur charges on your fund

You will incur investment and provider charges on your pension funds. Both of these can eat into investment growth and impact on the value of your fund.

It’s easy to make costly mistakes

Earlier on, we referred to the “potential intricacies” of pensions. These can mean that it’s easy to make mistakes when it comes to managing your retirement savings. Mistakes can prove costly, and in many cases can be irreversible.

We’d always recommend you get advice from an expert when it comes to investment choice and how you take money from your fund when you retire.

Both offer opportunities to grow your wealth

Ultimately, the decision between pension or property is not a binary one.

It’s possible to put together a mixed portfolio including both property and pension investments to help grow your wealth for retirement.

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