Property vs Pension - which is best?
One of the most common questions I’m asked as a financial planner is whether property or pension is the best choice when it comes to retirement.
This short blog will help you to understand:
“What’s best - property or pension?”
“How are property investments taxed?”
“What are the main considerations before investing in property?”
Investing in property remains a popular retirement strategy in the UK, with the Office for National Statistics (ONS) finding that 38% of self-employed workers viewed it as the safest way to save for retirement, with just 19% choosing a personal pension.
While personal pensions were the front runner for employed workers, 23% of those surveyed said they plan to use property to support their retirement.
Including some form of property investment in your retirement strategy could certainly work well for you. However, there are a variety of considerations you should make before taking the plunge.
As a financial planner in Bradford on Avon (who has invested in both), I’m well placed to outline some general points to consider when deciding whether to prioritise property or pension in your retirement strategy. However, if you’re looking for more specific financial advice then please get in touch.
Average returns on property beat inflation – but not the wider investment market
The first thing to consider when comparing property with pensions is past performance. While this is never a direct indicator for future performance of any investment, it can give you an idea of consistency in terms of value and returns.
In a comparison of house prices against the FTSE All-Share Index, a leading investment manager found that £100 invested in the stock market in 1986 would have grown to £1,755 by 2018. The same investment in property would have grown from £100 to £739, a considerably lower return.
While this does mean an investment in property would beat inflation, it wouldn’t keep track with equities, as a whole.
Costs of management for buy-to-let landlords
As we saw above, property underperforms against the stock market. And yet, it could almost certainly end up costing you more in fees and charges, especially if you’re considering a buy-to-let.
To start with, you’ll most likely purchase your property using a mortgage. While the money you’ll charge on rent can cover the costs of your mortgage payments, this will still heavily reduce your profit.
This is all aside from the costs of property maintenance, landlord insurance, redecorating, and any repairs you might have to undertake on the property. There’s also the risk of uncooperative tenants damaging the property further, or missing rent payments.
On the other hand, pensions have small management costs, and are usually taken as a percentage of the amount invested. As a result, if your costs are rising, that most likely means your pot has grown too.
Tax considerations
Costs of management become even more pronounced when you consider the tax structures of property and pension. Simply put, pensions have been deliberately designed to be tax-efficient, whereas property has not.
The pension Annual Allowance allows you to contribute up to £40,000 or 100% of your earnings (whichever is lower) into your pension in the 2020/21 tax year while still benefiting from tax relief.
Basic-rate taxpayers get an instant 20% boost to their contributions so, for every £80 you contribute, £100 will be invested in your pension. If you’re a higher or additional-rate taxpayer, you can claim an additional 20% or 35% relief through your tax return.
You can also normally access 25% of your pension pot tax free when you retire.
While pensions are highly tax-efficient, property can be subject to various forms of tax:
1. Stamp Duty – This is the tax you’ll pay for buying a residential property if you pay more than £125,000. And, rules for buying a second property mean you’ll usually pay an additional 3% in Stamp Duty on top of the standard amount. As an example, once the Stamp Duty holiday ends at the end of September 2021, you’d pay 5% Stamp Duty when you bought a second property valued at £200,000, equivalent to £10,000.
2. Capital Gains Tax (CGT) – You’ll usually be liable for CGT when you sell a second property if you make a profit. If you’re a basic-rate taxpayer, you’ll pay 18% tax on any profit above your annual exemption. If you’re in the higher or additional-rate tax bands, CGT will be charged at 28%.
3. Income Tax – If you’ve purchased your property to rent out, the income you make on rent payments will be taxed as part of your income (less some allowance expenses, and a 20% tax credit). This will be at your rate of Income Tax.
These tax payments can drive up the cost of buying and holding property and reduce the returns you’ll make.
Property can reduce the liquidity of your portfolio
Another issue with relying on property is that it’s an illiquid asset. This means you won’t be able to quickly access your money if need to, such as in an emergency. This is also true of pensions, up to aged 55.
However, unlike a pension, when you do eventually decide you want to access any money tied up in a property, you’ll have to go through the whole process of selling. For this, you’ll be entirely at the whim of the market as to whether you’ll find a buyer at all, and at what price they’ll be willing to buy. You’ll also have to consider the costs of estate agents and, potentially, Capital Gains Tax.
Meanwhile, thanks to Pension Freedoms, you can currently access your pension easily at aged 55 (rising to 57 in 2028), with the first 25% of any withdrawals you make being tax free.
Bear in mind that any withdrawals over this 25% threshold will be taxed as part of your income.
If you want more flexibility and liquidity in your retirement, property may not be the best choice for you.
Although pensions have greater flexibility, the fund does need to last for the rest of your lifetime. Accessing benefits early may result in reduced income in later life. While 25% of your fund can be accessed tax free, the remainder is taxable at your highest marginal rate. It may also have implications on the level of contributions you can make if your Annual Allowance is reduced.
Levels, base of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. If you’re not sure what the current rules are, please get in touch.
Diversifying your portfolio
One big advantage of prioritising your pension over property is that you can benefit from a wider range of investments, helping to diversify your holdings.
Your pension will typically be invested in a range of equities, commodities, bonds, and perhaps some property too. If investments in one asset fall in value, the money you have invested in other classes elsewhere could help to balance this out.
Owning a property is like only buying one share in one market: if it does badly, that’s your whole investment. To use a common phrase, your eggs are very much all in one basket.
Bear in mind that the property market is notoriously difficult to predict. In 2020, despite a pandemic-driven recession, house prices paradoxically rose. Don’t presume prices will behave just like they have in the past.
Not sure whether property or pension is right for you? Speak to a financial adviser
All things considered, there are pros and cons of both property and pensions. Returns on property over the long term have traditionally been relatively strong and stable, and so owning bricks and mortar could make a welcome addition to your retirement strategy.
However, property is illiquid, can be expensive to maintain as an investment, and you can end up with an unbalanced portfolio. Pensions can be flexible, allow you to diversify, and are highly tax-efficient.
It is often worthwhile considering a retirement strategy that’s as diverse as possible, so if you’re still not sure whether to prioritise property or pension, it’s best to speak to a financial planner.
Get in touch
If you would like help from a financial adviser in Bradford on Avon near Bath. Email daniel@wiltshirewealth.com or call 01225 699790 for more information.
Please note:
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.
Buy to let (pure) and commercial mortgages are not regulated by the Financial Conduct Authority.
