How to decide between property or a pension

Bank of England Monetary Policy Committee member Andy Haldane has suggested that investing in a property is a better approach to retirement than a pension. Adrian Lowcock, investment director at Architas, gives us his view on this.

How to decide between property or a pension

The idea of using a property as an alternative to a pension has appealed to many in recent years as property prices have continued to rise.

Rising prices have led investors to think borrowing to invest in property is relatively low risk, but it is not. Borrowing money to invest is particularly risky as if the investment falls in value you still owe the bank the original value of the loan.

As property becomes increasingly expensive and valuations rise, so do the risks. Investors should be wary of history repeating itself, especially as people’s income has not kept pace with property prices. Nothing goes up forever.

Property vs pension*

In the second quarter of 2016 an average house in the UK cost £204,238 (Source: Nationwide). For a first-time buyer the cost of purchasing such a property could be at least £25,000, including a 10% deposit. The additional cost of a 25 year mortgage at 3% would amount to over £10,000 per annum.

A 40% tax-payer could have a pension pot of £853,698 after 25 years, assuming 5% per annum return if they invested the lump sum and made regular annual contributions, matching the mortgage costs of buying an average property.

If the value of the property also grew by 5% each year it would only be worth £692,252 after 25 years. If the above pension pot generated 4% income after costs it would produce an annual income of £34,148 compared to £27,690 from the property – that is just over 24% more.

Both sources of income would be subject to income tax at the individual’s marginal rate of tax, although pension investors could take a 25% tax free lump sum.

Savings

Whether you choose property or a pension the key to getting a decent nest egg is saving something. However, the tax relief on pension contributions are clearly worthwhile.

A 40% taxpayer gets an additional boost to their savings which makes a significant difference over time. The pension could also benefit from any income being reinvested, whereas rental income from a property cannot be reinvested into the property. If reinvested income is taken into consideration the gap between the pension and the property might be considerably larger.

For many a property is first and foremost their home as well as their largest asset.  This is the best use of property as you reduce your living costs by paying off a mortgage which should fall over time instead of paying rent which is likely to rise.

A pension offers a tax efficient way to diversify your investments and spread the risk by providing exposure to other assets. In addition you can start saving into a pension straight away, from as little as £50 a month, instead of having to build up a large deposit before you can buy it.

Five tips to consider

Getting started – Buying a property will require an initial cost of thousands of pounds, whereas a pension can be started for as little as £50 a month, meaning you can start your retirement planning earlier.

Costs – The costs of owning and managing a property will vary with each property, however maintenance and administrations costs are likely to be considerably more for a property than the costs are for administering a pension.

Choice – In a pension you can choose to invest in a wide range of assets from equities to bonds as well as property ensuring you don’t hold your money in one asset. Property is only one asset class.

Liquidity – Property is illiquid, it cannot be sold quickly. Many investments inside a pension are more liquid and often easily tradeable.

Returns – Future performance of property and investments is not guaranteed. Don’t make an investment based on the returns you or others may have got in the past.

 

*Assumptions:

The calculations used above are based on a number of assumptions and exclusions to produce a simplified example for comparison.  Individual circumstances may differ as could future returns which would affect the outcome:

  • Maintenance cost of the property and administration costs of the pension are excluded
  • Mortgage costs are fixed at 3%; borrowers could get better deals by looking around but average APR rates are higher than 3%. Cost is £872 per month, £10,464 per annum.
  • Returns are based on 5% growth after fees and exclude dividends and rental income.
  • Costs of buying property calculated as £25,304. Including 10% deposit (£20,424), Survey & Valuation (£545), Mortgage arrangement fee (£1,000), Stamp Duty (£1,584.76), Removal costs £750, Solicitor Fees Land Registry and Conveyancing Costs (£1,000).

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