Do you treat your property as your pension or hear someone say their property is their pension? Just what does that mean and how does it affect your future?
Using your property as your pension means one of two things – you bought the largest house you can afford and will downsize in retirement, or you did a buy-to-let agreement.
Why do People Choose Property for their Pension?
It’s easy to see why many people use their property as their pension. The real estate market has grown tremendously through the years. UK property values greatly exceeded inflation by as much as 3% between 1955 and 2018.
Does this mean choosing a property for your pension is the right choice?
Not necessarily – it could cost you more than you realize down the road.
Understanding the Return on Investment – Property vs Pension
UK property values increased around 34.7% over the last ten years. That’s great news for those thinking about a property for their pension, but it’s not the only factor.
- If you rent your property out, there’s no guarantee of consistent income. Sure, the average UK rental yield is around 4%, but what about vacancies, issues with the home, or unexpected expenses? They all decrease your cash flow, aka your retirement fund.
- Downsizing may not provide the returns you anticipated. Between costs to sell a house and buy another, you may walk away with a profit much lower than you thought. Industry research found that between 2002 – 2003 and 2014 – 2015, movers between the ages of 50 – 59 only walked away with £4,000 after downsizing, not nearly enough to fund a retirement.
What about pension returns? Over the last 10 years, the UK stock market grew 63.9%. That’s not all:
- If you’re eligible, your employer must contribute at least 3% of your qualifying earnings to your pension. That’s like ‘free money’ and can help your pension grow quickly.
- You may also earn from the government if you’re younger than 75 and a UK resident. You’ll receive a 20% ‘bonus’ from the government when you contribute to your pension.
Consider Taxes – Property vs Pension
Another main concern is the taxation of your funds, property vs pension.
First, let’s look at property taxes.
- You’ll pay capital gains on any profits earned on real estate, usually 18% to 28% in capital gains taxes.
- You’ll pay income taxes at your marginal tax rate on any rental income earned.
- You may own stamp duty on primary residences over £500,000 until 1 July 2021, and then over £250,000 until 1 October 2021. The threshold may change to £125,000 after that point, the government rules change often, so there’s no way to know for sure. If you own additional properties, you may pay an additional 3% on those properties too.
Now let’s look at how your pension is taxed.
First, pensions defer your tax liabilities. There’s no income tax on dividends or interest earned on investments in your pension. Unlike non-retirement funds, any growth is free from capital gains tax.
Once you reach retirement age, you can access up to 25% of your private pension tax-free after age 55. The remaining funds will be subject to regular income taxes. Like property tax rules, these rules can change at any time, so always check the government website to be sure.
You’re also in control of when you pay taxes by only withdrawing the funds necessary to cover your expenses in that year. Spreading your withdrawals out over the years can lower your tax liabilities and give you greater retirement income.
Cash at Retirement – Property vs Pension
The big question everyone wants to know is how do you get the cash at retirement? Property wins in this debate since there aren’t any rules regarding when you can withdraw funds.
When you liquidate your property (at any age), you receive the funds. If you own a property to rent out, you can earn a steady income stream assuming you keep the property occupied. Whether you sell the property or earn rental income, you’ll pay the appropriate taxes when you earn it, which decreases the cash in hand.
With a pension, you have more control over the cash flow. You control how much (or little) money you withdraw. Each pension plan has different schemes and plans, it’s always best to consult with a financial advisor before withdrawing from your pension so you understand the full implications of your decision.
Risk – Property vs Pension
Any investment carries a risk and relying on one investment alone increases your risk even further. It’s like putting all your eggs in one basket, which is the case with using property as your pension.
When you only rely on property, you’re assuming you’ll make a profit. What if you don’t? No one can predict future real estate values. If you rent out a property, what if you can’t keep it occupied, the renters ruin the property, or you have unexpected expenses?
Property as a pension is a big risk.
If you contribute to a traditional pension, there’s still risk. There’s no guarantee the stock market will only improve. But, if you diversify your investments, you’ll offset the risk of a total loss. You get to choose your investments and with the help of a financial advisor, you can increase your chances of a profitable retirement.
Cost – Property vs Pension
At first glance, it’s easy to guess which costs more – property.
As of August 2020, the average property price in the UK was £239,000, up 2.5% from the previous year. Real estate prices change all the time too. If they get too high, your retirement scheme gets a lot more expensive.
Buying real estate also incurs other costs – the deposit may be higher than you anticipated, plus there are all the third-party costs to facilitate the sale. If the home needs renovations, you could be looking at thousands of dollars in costs.
If you rent the property, you’re in charge of all maintenance and repair costs, plus letting agent fees.
Pensions, on the other hand, don’t require a lot of capital. Obviously, you need to invest money to make money, but not to the tune of hundreds of thousands of dollars. You can contribute at your pace, based on what you can afford.
Pensions do have ongoing fees and management fees. Reading the fine print and choosing the investments with the lowest fees will create the largest profits.
The Practicality of Property vs Pension
Finally, you must consider the practicality of either investment.
Investing in property takes a lot of time, effort, and creates a lot of stress. Buying a property and maintaining it if you rent it out is a big job, not to mention expensive. You own your own business and are responsible for the ‘customers’ or your tenants.
If you sell a property, you send your life into complete upheaval. Where will you go? What will it cost? Are you ready to start your life over again in a new area? If you’re’ downsizing, it could be emotional, especially if you’re selling the property you raised your family in and a smaller home could create new challenges.
Pensions are a lot easier to manage. You can set up automatic enrolment so the hard work is done for you. With you and your employer contributing each month, your investment will grow (but it may fall too).
But, all responsibility for managing your pension falls on your shoulders. Don’t rely on the state pension alone – work with a financial advisor to ensure you’re contributing and investing effectively.
Property vs Pension – Which is Right for You?
Property vs pension isn’t a one-size-fits-all answer. Look at the big picture, understanding all fees, regulations, and even the work/stress involved. Work with a professional before deciding so you ensure you’re minimizing risk, diversifying your money, and increasing your chances of a peaceful retirement.
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